Prices & Decision Making

Overview & Objectives (Do Not Write) In chapter 4 we learned demand from the point of view of the consumer. In chapter 5 we learned about supply form the point of the view of the producer. Finally, we learn about price and how it serves as a communicator between the two in their fight to find equilibrium in the market. Remember, equilibrium is always the goal. In chapter 4 we learned demand from the point of view of the consumer. In chapter 5 we learned about supply form the point of the view of the producer. Finally, we learn about price and how it serves as a communicator between the two in their fight to find equilibrium in the market. Remember, equilibrium is always the goal.

Objectives for Chapter 6 Section 1 Explain how prices act as signals Explain how prices act as signals Describe the advantages of using price as a way to allocate resources Describe the advantages of using price as a way to allocate resources Understand the difficulty of allocation when we don’t use the price system. Understand the difficulty of allocation when we don’t use the price system.

Prices as Signals Price – Monetary value of a product as established by supply and demand Price – Monetary value of a product as established by supply and demand Price is neutral (Doesn’t favor either side) Price is neutral (Doesn’t favor either side) Price is flexible. (When unforeseen events occur, price adjusts) Price is flexible. (When unforeseen events occur, price adjusts) Price requires very little help. The authorities need not it adjust generally speaking. Price requires very little help. The authorities need not it adjust generally speaking. Price is firm and speaks every language. Everyone understands it and respects. Price is firm and speaks every language. Everyone understands it and respects.

Prices As Signals Think or Price as an Umpire in the never ending game between Supply and Demand.

The Price System The pricing system allows us to allocate our resources most efficiently. Remember, the problem of scarcity is fundamental. Resource allocation is crucial to a strong economy. The pricing system allows us to allocate our resources most efficiently. Remember, the problem of scarcity is fundamental. Resource allocation is crucial to a strong economy.

Alternatives to the Pricing System Often in Command economies, goods and services are reserved for those with the right connections. Often in Command economies, goods and services are reserved for those with the right connections.

Alternatives to the Pricing System Rationing in times of sever shortages my be necessary but comes with a number of problems. Rationing in times of sever shortages my be necessary but comes with a number of problems. 1. Corruption 1. Corruption 2. High Administrative Cost to keep “Fair” 2. High Administrative Cost to keep “Fair” Diminishing Incentive for all Diminishing Incentive for all

Terminology Rationing Functioning of Prices– system in which the government or authoritative agency decides each person’s “fair” share Rationing Functioning of Prices– system in which the government or authoritative agency decides each person’s “fair” share Ration coupon – allows for holder to redeem for certain amounts of a particular product Ration coupon – allows for holder to redeem for certain amounts of a particular product Rebate – partial refund of the price Rebate – partial refund of the price

Price System at Work Economic Model – set of assumptions listed in a table to help track economic data, combining the supply and demand curves to display the entire market Economic Model – set of assumptions listed in a table to help track economic data, combining the supply and demand curves to display the entire market Economic equilibrium – Supply = Demand Economic equilibrium – Supply = Demand

MARKET DEMAND & SUPPLY $ $ x 200 B U Y E R S PQDQD BUSHELS OF CORN MARKET DEMAND 2,000 4,000 7,000 11,000 16,000 x 200 S E L E R S 12,000 10,000 7,000 4,000 1,000 PQSQS BUSHELS OF CORN MARKET SUPPLY EQUILIBRIUM Graphically…

7 S P Q o $ PQDQD $ ,000 4,000 7,000 11,000 16,000 $ ,000 10,000 7,000 4,000 1,000 D PQSQS Price of Corn Quantity of Corn CORN MARKET CORN MARKET Market Clearing Equilibrium MARKET DEMAND & SUPPLY

7 S P Q o $ PQDQD $ ,000 4,000 7,000 11,000 16,000 $ ,000 10,000 7,000 4,000 1,000 D PQSQS Price of Corn Quantity of Corn CORN MARKET CORN MARKET Surplus At a $4 price more is being supplied than demanded MARKET DEMAND & SUPPLY

11 7 S P Q o $ PQDQD $ ,000 4,000 7,000 11,000 16,000 $ ,000 10,000 7,000 4,000 1,000 D PQSQS Price of Corn Quantity of Corn CORN MARKET CORN MARKET At a $2 price more is being demanded than supplied Shortage MARKET DEMAND & SUPPLY

Prices System Continued Surplus – Excess amount of a particular good and/or service Surplus – Excess amount of a particular good and/or service Shortage – Limited amount of a particular good and/ or service Shortage – Limited amount of a particular good and/ or service Equilibrium Price or Market Equilibrium– “Clears the Market” – Will leave neither a surplus or shortage Equilibrium Price or Market Equilibrium– “Clears the Market” – Will leave neither a surplus or shortage

Changes in Supply Price changes are heavily affected by real world circumstances. Surpluses or shortages severely effect market equilibrium. Price changes are heavily affected by real world circumstances. Surpluses or shortages severely effect market equilibrium. For example, instability in the Middle East is sending oil prices surging due to supply concerns For example, instability in the Middle East is sending oil prices surging due to supply concerns REVIEW YOUR SUPPLY DETERMINANTS REVIEW YOUR SUPPLY DETERMINANTS

Changes in Demand Consumer changes are no different either. Price will either decrease or increase based on the determinants given in chapter 4. (Income, Substitutes, Tastes, # of consumers, expectations) Consumer changes are no different either. Price will either decrease or increase based on the determinants given in chapter 4. (Income, Substitutes, Tastes, # of consumers, expectations)

Social Goals vs Market Efficiency Price Ceiling – Maximum amount that can be charged for a product Price Ceiling – Maximum amount that can be charged for a product Minimum Wage – the lowest legal wage that can be paid to workers Minimum Wage – the lowest legal wage that can be paid to workers Price Floor – Minimum price that can be charged for a good or service Price Floor – Minimum price that can be charged for a good or service

Competitive Theory of Pricing Based on ideal or “classroom” conditions stating that prices for similar goods will stay competitive from store to store Based on ideal or “classroom” conditions stating that prices for similar goods will stay competitive from store to store Certain conditions may alter price somewhat such as how informed a buyer is or where a store is located. Certain conditions may alter price somewhat such as how informed a buyer is or where a store is located.

Social Goals vs. Market Efficiency If price controls are set, markets are disrupted and equilibrium cannot be achieved. If price controls are set, markets are disrupted and equilibrium cannot be achieved. It is more important however at to achieve certain social goals as opposed to efficient markets. It is more important however at to achieve certain social goals as opposed to efficient markets. For example, minimum wage promotes economic equality. For example, minimum wage promotes economic equality.

Terminology Price Ceiling – Maximum legal price that can be charged for a product. Price Ceiling – Maximum legal price that can be charged for a product. Price Floor – Lowest legal price that can be paid for a product. Price Floor – Lowest legal price that can be paid for a product. Target Price - Target Price - Agricultural price floor set by the Government to stabilize farm incomes Deficiency Payment – Sent to producers to make up for the difference in the market price and the target price.

When Markets Talk The information that is exchanged between consumer and producer and vice versa can be described as “conversation within the market.” The information that is exchanged between consumer and producer and vice versa can be described as “conversation within the market.” Price as well as the other determinants serve as they language they use in achieving stability within the market Price as well as the other determinants serve as they language they use in achieving stability within the market