Prices

How Prices Work

Prices Decision-making tools that affect the behavior of individuals, businesses, markets, and industries

Prices act as signals – tell: people to buy more or less of a product producers to produce more or less of a product.

Rationing System in which government decides everyone’s “fair” share. Almost impossible to have a system that everyone agrees is fair

Rationing: has high administrative expenses distorts market incentives does not solve the basic problem of supply and demand can be abused and misused fairly easily

Price system can help allocate resources within/between markets.

Overall impact of higher prices in one market is to shift productive resources out of some industries and into others.

Because it helps allocate resources between markets, the price system is considered an informational network that links all markets in the economy.

The Effects of Prices

Buyers who want to find bargains and sellers who hope for large profits both play a part in determining prices.

Because transactions in a market economy are voluntary - the price compromise that settles the differences between buyers and sellers must benefit both parties.

When used together - supply and demand curves intersect at the equilibrium price where the quantity of products supplied equals the quantity demanded.

Surplus occurs when the price for a product is too high. Shortage occurs when the price for a product is too low.

In most cases, price is affected by concurrent changes in supply and demand. The price system is more efficient when markets are competitive.

Competitive markets allow prices to adjust naturally in response to surpluses and shortages allocate resources efficiently