The Roles of Prices Chapter 6 Section 3

Prices in a Free Market Help solve shortage and surplus problems Tool for distributing goods and resources Very efficient Centrally planned is the alternative; it is not efficient

The Advantages of Prices Provides a common language Price as an incentive Prices provide incentive to both demand and supply Buyers behave to prices in a certain way; as do suppliers (Law of Demand; Law of Supply)

The Advantages of Prices Prices as Signals Price gives information on production and demand for producers and buyers in the market

The Advantages of Prices Flexibility Prices can easily adjust to a supply shift or a demand shift Prices are more flexible than output levels (X-axis of graph) Supply Shock – sudden shortage Increase supply – time consuming Rationing – system of allocating goods not using price = expensive Raise prices – quickest way to alleviate shortage

The Advantages of Prices Price System is “Free” Costs nothing to administer Centrally planned takes thousands of bureaucrats to collect info and decide how to distribute goods and services Decisions are up to consumers and producers in free market

Choice and Efficiency Large diversity of goods and services to choose from Make decisions based on price (budget-based) Producers can set a target audience

Choice and Efficiency Rationing and Shortages Black Market Consumers have less choices, and have trouble finding goods USSR, US during WWII Black Market Market in which goods are sold illegally, without regard for govt. controls on price or quantity Efficient Resource Allocation Market system ensure that resources go to the uses that consumers value most highly

Prices and the Profit Incentive The Wealth of Nations by Adam Smith People prosper by finding out what people want, and the providing it. Heat Wave Scenario Coming heat wave Increase demand for air conditioners and fans and power to run them Suppliers see potential for profit with higher prices and produce more fans and air conditioners, and more power is produced to run them

Prices and the Profit Incentive Market Problems Imperfect competition not enough firms in market Negative externalities side effects of productions that have unintended costs (pollution) Imperfect information if buyer or sellers don’t have adequate information, they may not make the best decision