1. Prices and Decision Making

2. Price The monetary value of a product as established by supply and demand Signals: –High prices: producers to produce more and for buyers to buy less –Low prices: producers to produce less and for buyers to buy more

3. Advantages of Prices Prices – help decide: WHAT, HOW, AND FOR WHOM Prices are neutral in a competitive market economy –Result of competition b/w buyers and sellers: More competitive = more efficient price adjustment process

4. Prices are flexible in a market economy –Think about computers THEN and NOW –Allows for the “SHOCK” of unforeseen events and changes in the market Prices have no administration cost –Competitive markets find their own prices w/out interference –Prices change from one level to another gradually Advantages of Prices

5. Prices are familiar and easily understood –Mommy “I want a candy bar!” –You “Can I purchase that TV?” –No ambiguity: if it is $1 then you know you will pay $1 (plus tax in some states) –Make quick decisions –Minimum effort Advantages of Prices

6. Allocations Without Prices Help us make economic decisions that “allocate” scarce resources and the product made from them What if the PRICE SYSTEM did not exist? –Like command economies –Use another system right?

7. Rationing: –System where the government decides everyone’s “FAIR” share –RATION COUPON: Obtain a certain allotted amount Widely used during wartime –Questions of Fairness? –High Administrative cost –Diminishes incentives Allocations Without Prices

8. Price as a System Economists favor the price system Serve as signals that help allocate resources between markets –Oil ($5 to $40 a barrel in 1970’s) –Oil is inelastic –Higher energy cost = less money to spend elsewhere –1 ST affected full size automobiles –Gave rebates: a partial refund of the original price of the product –Closed plants, laid off workers, started to change to small production

9. Higher prices on oil = shift in productive resources Prices help buyers and sellers allocate resources b/w markets Economist think of the price as a system –Part of an informational network –Links all markets in the economy Price as a System

10. The Price System at Work

11. The Price Adjustment Process Appealing feature of a Competitive Market Economy –EVERYONE who participates has a hand determining PRICES –Makes prices neutral and impartial Buyers and sellers have exactly the OPPOSITE hopes and desire –Buyers = find good buys at low price –Sellers = high prices and large profits –Neither can get what they WANT so adjustments must be made

12. Compromise needs to benefit BOTH parties DEMAND and SUPPLY make a complete picture of the market Price adjustments help a competitive market reach market equilibrium, with fairly equal supply and demand See figure 6.1 The Price Adjustment Process

13. Reflects the LAW OF DEMAND: Consumers will buy more at lower prices and less at higher prices Reflects the LAW OF SUPPLY: Suppliers will offer more for sale at higher prices and less at lower ones

14. SURPLUS= occurs when supply EXCEEDS demand SHORTAGE= occurs when demand EXCEEDS supply EQUILIBRIUM PRICE = occurs when supply MEETS demand

15. Surplus Shows up as UNSOLD products on suppliers shelves Takes up space Know that the price is TOO high NEED to LOWER the price to attract buyers PRICES tend to go DOWN when there is a surplus

16. Shortage Suppliers have no more product to SELL Wished they would have charged a higher price Result = BOTH price and quantity supplied will go UP We do not know how much PRICE will go up

17. Equilibrium Price “Clears the market” neither a surplus nor a shortage at the end of the trading period Economic Model of the market –CANNOT know how long it will take to reach Price is set TOO HIGH the surplus will tend to force price down Price is set TOO LOW the shortage will ten to force price up

18. Explaining and Predicting Prices A change in price is the result of a –Change in Supply –Change in Demand –Or BOTH Elasticity of Demand is also important when predicting prices

19. What causes change of supply with Agriculture? –Answer: ____________________________ See figure 6.3 –SS = curve the farmer predicted –S1S1 = curve would move to if there was a record harvest –S2S2 = curve would move to if there was bad weather Food is INELASTIC a small change in supply = large change in PRICE Explaining and Predicting Prices: Change in Supply

20. Change in Supply

21. Demand curve is MORE elastic When a given change in supply occurs with an INELASTIC demand curve –PRICES change dramatically When a change in supply occurs with an ELASTIC demand curve –Price change is smaller BOTH supply and demand are INELASTIC = wider change in price BOTH supply and demand are ELASTIC = less change in price Explaining and Predicting Prices: Importance of Elasticity

22. Changes in income, taxes, prices of related goods, expectations, and number of consumers Example: GOLD Explaining and Predicting Prices: Change in Demand

23. The Competitive Price Theory The theory of competitive pricing represents a set of ideal conditions and outcomes; it serves as a model to measure market performance Competitive market allocates resources efficiently To be competitive: –Sellers are forced to lower prices –Find ways to keep cost down Competition among buyers keeps prices from falling TOO far

24. Social Goals vs. Market Efficiency

25. Distorting Market Outcomes Seven Economic goals compatible with the market economy –Freedom –Efficiency –Full employment –Price stability –Economic growth Two others: Equity and Security –Usually distort market outcomes –One way to achieve these goals is to set “socially desirable” prices, which interferes with the pricing system.

26. Price Ceilings A maximum legal price that can be charged for a product –New York City does this with rent control to make housing more affordable. –This can create a shortage. How? Affects allocation of resources

27. Price Floors Lowest legal price that can be paid for a good or service –Minimum wage Lowest legal wage that can be paid to most workers at 7.25 –This can create a surplus. How?

28. Agricultural Price Supports 1930’s est. Commodity Credit Corporation –Help stabilize agricultural prices –Used loan supports and deficiency payments –BOTH used target price: a price floor for farm products

29. Loan Support Borrowed money from CCC at the target price and pledged his crops in return Led to food surpluses Nonrecourse loan: a loan that carries neither a penalty nor further obligation to repay if not paid back

30. Deficiency payments Check sent to producers that makes up the difference between the actual market price and the target price Prevented the gov’t from holding surplus foods Had farmers sell crops on the open market

31. Federal Agricultural Improvement and Reform Act (FAIR) Cash payments replaced price supports and deficiency payments Cost just as much 2002, farmers no longer receive any kind of payments

32. When Markets Talk Markets “talk” when prices move up or down dramatically Buyers and sellers respond to changes in the market through their decisions