1. The Roles of Prices
Chapter 6 Section 3

2. 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

3. 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)

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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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