Economics Chapter 6: Prices and Decision Making Economics Chapter 6: Prices and Decision Making Prices serve as signals to both producers and consumers.

Economics Chapter Economics Chapter 6:6:

Prices and Decision Prices and Decision MakingMaking

Economics Chapter 6: Economics Chapter 6: Prices and Decision Prices and Decision

MakingMaking• PricesPrices serve as signals to both producers serve as signals to both producers and consumers. In doing so, they help and consumers. In doing so, they help decide the basic WHAT, HOW, and FOR decide the basic WHAT, HOW, and FOR WHOM questions that all societies face.WHOM questions that all societies face.

• High prices are signals for businesses to High prices are signals for businesses to produce more and for consumers to buy produce more and for consumers to buy less. Low prices are signals for less. Low prices are signals for businesses to produce less and for businesses to produce less and for consumers to buy more.consumers to buy more.


MakingMaking• Prices have the advantage of neutrality, Prices have the advantage of neutrality,

flexibility, efficiency, and clarity.flexibility, efficiency, and clarity.

• Other non-price allocation methods Other non-price allocation methods such as such as rationingrationing can be used. Under can be used. Under such a system, people receive such a system, people receive ration ration couponscoupons, which are similar to tickets or , which are similar to tickets or receipts that entitle the holder to receipts that entitle the holder to purchase a certain amount of a product.purchase a certain amount of a product.


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•Non-price allocation systems Non-price allocation systems suffer from problems suffer from problems regarding fairness, high regarding fairness, high administrative costs, and administrative costs, and diminished incentives to diminished incentives to work and produce.work and produce.


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• A market economy is made up of A market economy is made up of many different markets and many different markets and different prices prevail in each. A different prices prevail in each. A change in price in one market change in price in one market affects more than the allocation of affects more than the allocation of resources in that market. It also resources in that market. It also affects the allocation of resources affects the allocation of resources between markets.between markets.


MakingMaking11stst left hand page Question #1: left hand page Question #1:

Imagine that no matter how Imagine that no matter how much you studied, you already much you studied, you already knew you were going to get a knew you were going to get a “C” in economics. How would “C” in economics. How would this affect your incentive to this affect your incentive to study? Explain your answer.study? Explain your answer.


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The Price System At WorkThe Price System At Work

• Because transactions in a market Because transactions in a market economy are voluntary, the economy are voluntary, the compromise that eventually takes compromise that eventually takes place must be to the benefit of both place must be to the benefit of both parties, or the compromise would parties, or the compromise would not occur in the first place.not occur in the first place.


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• Economists use an Economists use an economic economic modelmodel to show how we reach to show how we reach market equilibriummarket equilibrium → a situation → a situation in which prices are relatively in which prices are relatively stable, and the quantity of goods stable, and the quantity of goods and services supplied is equal to and services supplied is equal to the quantity demanded.the quantity demanded.


MakingMaking• SurplusSurplus is a situation in which the is a situation in which the

quantity supplied is greater than quantity supplied is greater than the quantity demanded at a given the quantity demanded at a given price.price.

• ShortageShortage is a situation in which is a situation in which the quantity demanded is greater the quantity demanded is greater than the quantity supplied at a than the quantity supplied at a given price.given price.


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•Equilibrium PriceEquilibrium Price is the price is the price that “clears the market” by that “clears the market” by leaving neither a surplus nor leaving neither a surplus nor a shortage at the end of the a shortage at the end of the trading period.trading period.


MakingMaking11stst left hand page Question #2: left hand page Question #2:

Imagine that you want to go to a Imagine that you want to go to a concert but you find out it is sold concert but you find out it is sold out at ticket outlets. What effect out at ticket outlets. What effect will this shortage of tickets have will this shortage of tickets have on the price of any remaining on the price of any remaining concert tickets? Explain.concert tickets? Explain.


MakingMaking

Effects of a Surplus Effects of a Shortage

On Prices ↓ On Prices ↑

On Demand ↓ On Demand ↑

On Supply ↑ On Supply ↓


MakingMaking22ndnd left hand page Question #1: left hand page Question #1:

U.S. soybean farmers had a U.S. soybean farmers had a record-high harvest in 1998. record-high harvest in 1998. What likely affect did the What likely affect did the increase in the supply of increase in the supply of soybeans have on their price? soybeans have on their price? ExplainExplain


MakingMakingMarket Demand and Supply Schedule

Price Quantity Demanded Quantity Supplied Surplus/Shortage

$30 0 13 13

$25 1 11 10

$20 3 9 6

$15 6 6 0

$10 10 3 -7

$5 15 0 -15


MakingMaking• In a competitive market, prices are In a competitive market, prices are

established by the forces of supply and established by the forces of supply and demand. If the price is too high, a demand. If the price is too high, a temporary temporary surplussurplus appears until the appears until the price goes down. If the price is too low, price goes down. If the price is too low, a temporary a temporary shortageshortage appears until the appears until the price rises. Eventually the market price rises. Eventually the market reaches the reaches the equilibrium priceequilibrium price where where there is neither a shortage nor a there is neither a shortage nor a surplus.surplus.


MakingMaking•A change in price can be caused by A change in price can be caused by

a change in supply or a change in a change in supply or a change in demand. The size of the price demand. The size of the price change is affected by the elasticity change is affected by the elasticity of both curves. The more elastic of both curves. The more elastic the curves, the smaller the price the curves, the smaller the price change; the less elastic the curves, change; the less elastic the curves, the larger the price change.the larger the price change.


MakingMaking• The The Theory of Competitive PricingTheory of Competitive Pricing

represents a set of ideal conditions represents a set of ideal conditions and outcomes. The theory serves as and outcomes. The theory serves as a model by which to measure the a model by which to measure the performance of other, less performance of other, less competitive markets. Because of competitive markets. Because of this, absolutely pure competition is this, absolutely pure competition is not needed for the theory of not needed for the theory of competitive pricing to be practical.competitive pricing to be practical.


MakingMakingSocial Goal vs Market Social Goal vs Market

EfficiencyEfficiency

•Governments sometimes fix Governments sometimes fix prices at levels above or below prices at levels above or below the equilibrium price to achieve the equilibrium price to achieve the social goals of equity and the social goals of equity and security.security.


MakingMaking• Price CeilingPrice Ceiling – a maximum legal price – a maximum legal price

that can be charged for a product.that can be charged for a product.• Price FloorsPrice Floors – the lowest legal price – the lowest legal price

that can be paid for a good or service.that can be paid for a good or service.• If the fixed price is a If the fixed price is a price ceilingprice ceiling, as , as

in the case of rent controls, a shortage in the case of rent controls, a shortage usually appears fir as long as the price usually appears fir as long as the price remains fixed below the equilibrium remains fixed below the equilibrium price.price.


MakingMakingTarget PriceTarget Price – a price floor for farm products – a price floor for farm products

Agricultural price supports were introduced Agricultural price supports were introduced during the 1930s to support farm incomes. during the 1930s to support farm incomes.

• Non-Course Loan support programsNon-Course Loan support programs allowed farmers to borrow against crops allowed farmers to borrow against crops and then keep the loan or forfeit the crop if and then keep the loan or forfeit the crop if market prices were low.market prices were low.


MakingMaking•Later Later deficiency paymentsdeficiency payments

were used, supplying the were used, supplying the farmer with a check that farmer with a check that made up the difference made up the difference between the between the target pricetarget price and the actual price and the actual price received for the product.received for the product.


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•““When Markets TalkWhen Markets Talk” – are ” – are said to talk when prices in said to talk when prices in them move up or down them move up or down significantly.significantly.


MakingMaking22ndnd left hand page Question #2: left hand page Question #2:

Think of the last item you Think of the last item you decided not to buy. What decided not to buy. What message did your decision message did your decision send to the manufacturer? send to the manufacturer? Explain your answer.Explain your answer.


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THETHE

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Economics Chapter 6: Prices and Decision Making Economics Chapter 6: Prices and Decision Making Prices serve as signals to both producers and consumers.

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