Chapter 5 Prices Section 1 The Price System 1

I. The Language of Prices Prices are the main form of communication between producers and consumers 2

II. Benefits of a Price System Provides: A. Information Price of resources determines how much producers charge for their products Prices allow consumers to know the relative value of different products 3

B. Incentives High prices give suppliers incentive to supply more (Law of Supply) Low prices give consumers incentive to buy more (Law of Demand) C. Choice By encouraging participation in markets, the price system increases choices Ex. athletic clothing can range from $20 to $300 for designer brands 4

D. Efficiency Brings out efficiency in 2 ways: 1)Wise use of resources Producers will only use resources to provide goods and services consumers want 2) Allows consumers to quickly compare value of products 5

E. Flexibility The price system can accommodate changes in supply and demand quickly Ex. Freezes, floods, wars, work stoppages reduce supply Ex. A hit movie increases demand for hair or clothing styles 6

III. Limitations on the Price System Market failures occur because the price system fails to account for some production costs and therefore prices are not accurate 7

A. Externalities Side effects for people not directly connected with the production or consumption of the goods Negative externality--people become part of the cost when not part of production Factory pollution Positive externality—people benefit even when not a part of production Restaurant near factory 8

B. Public Goods Any good or service that is consumed by all members of a group Ex. National defense, judicial system, law enforcement C. Instability Drastic drop in prices may cause businesses to go out of business 9

Chapter 5 Prices Section 2 Determining Prices 10

The price system helps producers and consumers reach market equilibrium The quantity supplied and the quantity demanded are equal at the same price The needs of both producers and consumers are satisfied Producers and consumers have communicated effectively I. Equilibrium 11

How does the price system steer producers and consumers toward the equilibrium point? 12

A surplus exists when the quantity supplied exceeds the quantity demanded at the price offered A. Surpluses 13

A shortage exists when the quantity demanded exceeds the quantity supplied at the price offered B. Shortages 14

A. Demand Changes Consumer tastes and preferences Market size Income Prices of related goods Consumer expectations II. Shifts in Equilibrium 15

B. Supply Changes Government actions Technology Competition Producer expectations Prices of resources Prices of related goods II. Shifts in Equilibrium 16

What happens to the equilibrium point when either the demand or supply curve shifts? 17

Chapter 5 Prices Section 3 Managing Prices 18

Government sometimes sets prices to protect producers and consumers from dramatic price swings A. Price Ceiling A government regulation that establishes a maximum price for a particular good Ex. Rent control I. Setting Prices 19

B. Price Floor Government regulation that establishes a minimum level for prices More common than price ceilings Ex. Large Ag products, minimum wage The lowest amount an employer legally can pay a worker for a job 20

Most economists advise against the use of price ceilings and price floors Price ceilings tend to result in shortages Price floors tend to result in surpluses II. Consequences of Setting Prices 21

22

23

System in which a government decides how to distribute a product Ex. During WWII-- tires, meat, gas, and butter were rationed III. Rationing 24

A. Unfairness All people should be allowed to buy tickets for example, not just students and alumni B. Cost Must put money into the system of rationing (coupons, man hours) C. Black Market Goods exchanged illegally at prices that are higher than officially established prices IV. Consequences of Rationing 25