Economics Chapter 5

Section 1 Objectives: 1. What is the role of the price system? 2. What are the benefits of the price system? 3. What are the limitations of the price system?

The Price System Prices serve as the main form of communication between producers and consumers in a free-enterprise market. Prices are the way in which producers tell consumers how much it cost to produce and distribute a product. Consumers respond to price by buying the product or not.

Benefits of the Price System 1. Information -Producers: price of resources to make product, no way to know what product is most profitable. -Consumers: helps make informed buying decisions. Example-cost of sweater compared to a t-shirt.

Benefits of the Price System 2. Incentives -Producers: High prices encourage producers to make more. Lowers prices lead to lower production. -Consumers: High prices lead to lower demand. Low prices lead to higher demand.

Benefits of the Price System 3. Choices -Prices are high which leads to more production by sellers. More production leads to more competition that promotes more products and choices.

Benefits of the Price System 4. Efficiency -Provides for the wise use of resources. -Quickly delivers information to consumers and producers by helping them make quick decisions.

Benefits of the Price System 5. Flexibility -Prices can easily adjust to trends and disasters.

Limitations of the Price System Sometimes we have market failure meaning that the market fails to allocate resources. The Prices System has three limitations.

Limitations of the Price System 1. Externalities-when people who do not produce or consume a good experience some side effect from the good. Two types of Externalities: A. Negative externality-when externality has a negative impact such as pollution or a dog barking. B. Positive externality-when externality has a positive impact such as education.

Limitations of the Price System 2. Public Goods-any good or service that is consumed by all members of a group, usually provided by the government. What is the major problem with public goods? Free Riders-people who use public goods, but do not pay for them.

Limitations of the Price System 3. Instability-flexibility can make the system unstable. Drastic drop in price may make some companies go out of business.

Chapter 5 Section 2

Objectives What is market equilibrium? How does the price system handle product surpluses and shortages? How do shifts in demand and supply affect market equilibrium?

Determining Prices Price system helps producers and consumers reach market equilibrium- situation that occurs when the quantity supplied and the quantity demanded for a product are equal at the same price. Point at which the supply curve and demand curve intersect and a particular price and quantity is called the equilibrium point.

Equilibrium What happens when there is no market equilibrium? Two possible situations: 1. Surplus-exists when the quantity supplied exceeds the quantity demanded. This tells producers that they are charging too much for their product. 2. Shortage-exists when the quantity demanded exceeds the quantity supplied at the price offered. This tells producers that they need to raise their price so that demand will decrease.

Shifts in Equilibrium We know that there are factors that cause the demand and supply curves to shift. When this happens, the equilibrium point will also shift.

Chapter 5 Section 3

Objectives 1. Why do governments sometimes set prices? 2. What do governments try to accomplish through price floors, price ceilings, and rationing? 3. What happens when governments manage prices?

Managing Prices We know that the price system has limitations. -Externalities, Public Goods, and Instability. Government steps in to set prices to protect producers and consumers from dramatic changes in price.

Setting Prices Price Ceiling-government regulation that sets the maximum price for which a producer can sell a good. -Example: Rent Control Price Floor-government regulation that sets the minimum price for which a producer can sell a good. -Example: Minimum Wage

Consequences of Setting Prices If a Price Ceiling is set below the equilibrium point, then a shortage will occur. -Figure 5.4 pg. 109 If a Price Floor is set above the equilibrium point, then a surplus will occur. -Figure 5.5 pg. 110

Rationing Sometimes supply of a good is so low that the government has to ration the good. Rationing-System in which a government or other institution decides how to distribute a product. Example-Food rationing during WWII, college football ticket rationing.

Consequence of Rationing Three Consequence of Rationing: 1. Unfair-some people get the goods, some do not receive the goods. 2. Expensive-must pay for human resources used to implement and oversee the rationing system. 3. Black market-unfair distribution of product leads to the development of an underground market for the goods that takes advantage of people’s desire for the good.