2 How the Price System Works More producers in a market increases supply which leads to increased competition and a lower equilibrium priceCompetitive pricing occurs when producers sell goods and services at lower prices to lure customers away from rival producers while still making a profit
3 Example: Competitive Pricing Elm Street Hardware prices its snow shovels at $20Uptown Hardware prices its snow shovels at $13Uptown would then have a lower profit margin per shovel but ideally it would sell more shovels at the lower price of $13
4 Characteristics of the Price System In a market economy, the price system has 4 characteristics:1. It is neutral: the interaction between producers and consumers determines the equilibrium price in the market.
5 Characteristics of the Price System (continued) 2. It is market driven: market forces determine price of goods/services
6 Characteristics of the Price System (continued) 3. It is flexible: when market conditions change, prices change too. Surpluses and shortages motivate producers to changes prices to reach equilibrium.
7 Characteristics of the Price System (continued) 4. It is efficient: prices will adjust until the maximum number of goods and services are sold.
8 Prices Motivate Producers and Consumers The laws of demand and supply show that consumers and producers have different attitudes toward priceConsumers want to buy at low pricesProducers want to sell at high prices
9 Prices and ProducersThe price system has 2 great advantages: it provides information and motivation
10 Prices and Producers (continued) Prices provide information by acting as signals to producers about whether or not it is a good time to enter/leave a marketRising prices and the expectation of profits motivate producers to enter a marketFalling prices and the possibility of losses motivate them to leave a market
11 Prices and Producers (continued) A shortage is a market signal that consumer demand is not being met by existing suppliersProducers see that as an opportunity to raise pricesHigher prices are an incentive for producers to enter a market
12 Prices and Producers (continued) When more producers are motivated by higher prices to enter a market, quantity supplied increasesWhen prices are too high relative to consumer demand, a surplus occurs
13 Prices and Producers (continued) Producers respond to a surplus by reducing prices or reducing productionFalling prices are a signal that it is a good time for producers to leave the market
14 Prices and Producers (continued) While prices are signals that are visible in the market, it is the expectation of profits or the possibility of losses that motivated producers to enter or leave a market
15 Prices and ConsumersPrices also act as signals and incentives for consumersSurpluses that lead to lower prices tell consumers that it is a good time to buy a particular good/service
16 Prices and Consumers (continued) Producers send signals to consumers in the form of advertising and store displays
17 Prices and Consumers (continued) High prices discourage consumers from buying a particular productOften high prices are a signal that it is time for a consumer to switch to a substitute good with a lower price
18 Prices and Consumers (continued) A high price may signal that a good is in short supply or has a higher statusThink name brand goods
20 Price CeilingsDefinition: the legal maximum price that sellers may charge for a good/serviceThis is a price below the equilibrium price and results in a shortage
21 Example: Rent Control as a Price Ceiling Rent control means that despite what is going on in the market, rent prices cannot exceed a certain levelThis leads to a shortage of rental propertiesOften these rental properties are not well-maintained due to the fact that the rent cannot go above a certain point
22 Price FloorsDefinition: legal minimum price that buyers must pay for a good/service
23 Example: Minimum Wage as a Price Floor Minimum wages are set below the equilibrium price to prevent the wage from becoming unprofitable
24 Rationing Resources and Products The market uses prices to allocate goods and servicesRationing is an example in which the government allocates goods/services using a factor other than price
25 Rationing Resources and Products (continued) Generally a rationing system uses coupons that allow each person only a certain amount of a specific goodThe black market, the illegal buying and/or selling of a good, can be used to avoid rationing
26 Questions1. A local supermarket decides to sell a premium brand of meats and cheeses in its deli department. This brand is priced $2 more per pound than the store brand. About 80% of the space in the deli display cases is devoted to the premium brand and 20% to the store brand.A. How did price serve as an incentive to the supermarket?B. What kind of signals is the supermarket sending to its customers with this pricing strategy?
27 2. The percentage of workers who were paid the minimum wage or less decreased from 6.5% in 1988 to 3% in to 2.7% in What does this trend tell you about the relationship of the minimum wage to the equilibrium wage for those kinds of work?