1. Prices and Decision Making
Chapter 6
Prices and Decision Making

2. 6.1: Prices as Signals Explain how prices act as signals.
Describe the advantages of using prices as a way to allocate economic products.
Understand the difficulty of allocating scarce goods and services without using prices.

3. Vocab
Price
Rationing
Ration Coupon
Rebate

4. Introduction Life is full of signals that help us make decisions
Ex when you pull up to an intersections you look at the stop light
Turn signals
But what signals help us with our economic decisions?

5. Price
The monetary value of a product as established by supply and demand
Signal that helps us make economic decisions

6. Prices communicate information and provide incentives to buyers and sellers
High prices are signals for producers to produce more, buyers to buy less
Low prices are signals for producers to produce less, buyers to buy more

7. Advantages of Prices
Prices help to answer the 3 questions of WHAT, HOW, and FOR WHOM to produce
1) Prices are neutral because they don’t favor the buyer or the consumer. Result of competition
2) Prices are flexible, allowing for the “shocks” of unforeseen events and changes in the market
3) Prices have no administrative costs
4) Prices are familiar and easily understood

8. Allocations Without Prices
What does it look like without prices?
Rationing is an alternative
system where the government decides everyone’s “fair” share
Leads to the question of fairness
People would receive a ration coupon, permit allowing holder to receive a given amount of a rationed product
Commonly used during times of war by countries

10. Problems with rationing
People feel their share is too small
What is fair?
Administrative cost of rationing
Cost of making coupons, coupons being stolen/counterfeited
Negative impact on the incentive to produce

11. Prices as a System Economists overwhelmingly favor prices systems
Prices compromise a system that helps buyers and sellers allocate resources between markets
Links all markets in the economy

12. Turn to a neighbor and discuss the following questions…
In our opinion why does the neutrality of prices stimulate completion?
Imagine that no matter how much you studied you were going to get a B in this class. How would this affect your incentive to study?
*Write down your partner’s answer. Once you both have shared find a new partner to share your old partners answer with and vice versa.