Prices and Decision Making

Jump Start Chapter 6 section 11. Prices perform the allocation function well because they do all of the following :

A. Provide neutrality, favoring neither the producer or consumer B. Provide flexibility, absorbing unexpected shocks C. Enable the government to use rationingD. Provide ways for consumers to make decisions

2. All of the following are characteristics of rationing except A. Rationing is often viewed as unfair B. Rationing creates high administrative cost C. Rationing decreases the incentive to work D. Rationing provides an efficient link between producers and consumers

3. In a market economy, a high price is a signal for A. Producers to produce more and buyers to buy less B. Producers to produce more and buyers to buy more C. Producers to produce less and buyers to buy less D. Producers to produce less and buyers to buy more

4. In a market economy, a low price is a signal for A. Producers to produce more and buyers to buy less B. Producers to produce more and buyers to buy more C. Producers to produce less and buyers to buy less D. Producers to produce less and buyers to buy more

5. Economist think of prices as a “system” because A. They help buyers and sellers allocate resources between markets B. They convey information to the government C. They convey information to other countries D. They make rationing necessary at times

Price

• The monetary value of a product as established by supply and demand

• Signals:– High prices: producers to produce more

and for buyers to buy less – Low prices: producers to produce less

and for buyers to buy more

Advantages of Prices

• Prices– help decide: WHAT, HOW, AND FOR WHOM

• Prices are neutral in a competitive market economy – Result of competition b/w buyers and sellers:

• More competitive = more efficient price adjustment process

• Prices are flexible in a market economy– Think about computers THEN and NOW – Allows for the “SHOCK” of unforeseen events

and changes in the market

• Prices have no administration cost – Competitive markets find their own prices

w/out interference – Prices change from one level to another

gradually

Advantages of Prices

• Prices are familiar and easily understood – Mommy “I want a candy bar!”– You “Can I purchase that TV?”– No ambiguity: if it is $1 then you know you will

pay $1 (plus tax in some states)– Make quick decisions – Minimum effort

Advantages of Prices

Allocations Without Prices

• Help us make economic decisions that “allocate” scarce resources and the product made from them

• What if the PRICE SYSTEM did not exist?– Like command economies – Use another system right?

• Rationing: – System where the government decides

everyone’s “FAIR” share– RATION COUPON:

• Obtain a certain allotted amount • Widely used during wartime

– Questions of Fairness?– High Administrative cost – Diminishes incentives

Allocations Without Prices

Price as a System

• Economists favor the price system • Serve as signals that help allocate resources

between markets– Oil ($5 to $40 a barrel in 1970’s)– Oil is inelastic – Higher energy cost = less money to spend elsewhere – 1ST affected full size automobiles – Gave rebates: a partial refund of the original price of

the product – Closed plants, laid off workers, started to change to

small production

• Higher prices on oil = shift in productive resources

• Prices help buyers and sellers allocate resources b/w markets

• Economist think of the price as a system – Part of an informational network – Links all markets in the economy

Price as a System

Jump Start Chapter 6 section 11. Prices perform the allocation function well because they do all of the following Except :

A. Provide neutrality, favoring neither the producer or consumer B. Provide flexibility, absorbing unexpected shocks C. Enable the government to use rationingD. Provide ways for consumers to make decisions

2. All of the following are characteristics of rationing except A. Rationing is often viewed as unfair B. Rationing creates high administrative cost C. Rationing decreases the incentive to work D. Rationing provides an efficient link between producers and consumers

3. In a market economy, a high price is a signal for A. Producers to produce more and buyers to buy less B. Producers to produce more and buyers to buy more C. Producers to produce less and buyers to buy less D. Producers to produce less and buyers to buy more

4. In a market economy, a low price is a signal for A. Producers to produce more and buyers to buy less B. Producers to produce more and buyers to buy more C. Producers to produce less and buyers to buy less D. Producers to produce less and buyers to buy more

5. Economist think of prices as a “system” because A. They help buyers and sellers allocate resources between markets B. They convey information to the government C. They convey information to other countries D. They make rationing necessary at times

The Price System at Work

1. In a competitive market, the adjustment process moves toward market A. Equilibrium B. Surplus C. Shortage D. Model

2. If there is a shortage in a market, the price is likely to A. Increase B. Decrease C. Remain the same D. Fluctuate

3. If there is a surplus in a market, the price is likely to A. Increase B. DecreaseC. Remain the same D. Fluctuate

4. The theory of competitive pricing represents A. A model by which to measure the performance of other less competitive markets B. An important theory in economics C. A set of ideal conditions and outcomes D. All of the above

5. An economic model is described by all of the following except:A. It is a set of assumptions that can be listed in a table, illustrated with a graph, or

even stated algebraically B. It can be used to help analyze behavior C. It can be used to predict outcomes D. It is usually so complex that is can be understood by economists

Jump Start Chapter 6 section 2

The Price Adjustment Process

• Appealing feature of a Competitive Market Economy– EVERYONE who participates has a hand determining

PRICES – Makes prices neutral and impartial

• Buyers and sellers have exactly the OPPOSITE hopes and desire – Buyers = find good buys at low price – Sellers = high prices and large profits– Neither can get what they WANT so adjustments

must be made

• Compromise needs to benefit BOTH parties

• DEMAND and SUPPLY make a complete picture of the market

• Price adjustments help a competitive market reach market equilibrium, with fairly equal supply and demand

• See figure 6.1

The Price Adjustment Process

Figure 6.1aFigure 6.1a

Reflects the LAW OF DEMAND:

Consumers will buy more at lower prices and less at higher

prices

Reflects the LAW OF SUPPLY:

Suppliers will offer more for sale at higher prices and less at

lower ones

Figure 6.1bFigure 6.1b

Represents the supply and demand sides of the market

Figure 6.1aFigure 6.1aSURPLUS= occurs

when supply EXCEEDS demand

SHORTAGE= occurs when demand

EXCEEDS supply

Figure 6.1aFigure 6.1a

EQUILIBRUIM PRICE = occurs when supply

MEETS demand

Figure 6.1bFigure 6.1b

Figure 6.2aFigure 6.2a

SURPLUS= occurs when supply

EXCEEDS demand

Figure 6.1aFigure 6.1a

Surplus

• Shows up as UNSOLD products on suppliers shelves

• Takes up space

• Know that the price is TOO high

• NEED to LOWER the price to attract buyers

• PRICES tend to go DOWN when there is a surplus

Figure 6.2bFigure 6.2b

Figure 6.1aFigure 6.1aSHORTAGE= occurs

when demand EXCEEDS supply

Shortage

• Suppliers have no more product to SELL

• Wished they would have charged a higher price

• Result = BOTH price and quantity supplied will go UP

• We do not know how much PRICE will go up

Figure 6.2cFigure 6.2c

Figure 6.2dFigure 6.2d

EQUILIBRUIM PRICE = occurs when supply

MEETS demandFigure 6.1aFigure 6.1a

Equilibrium Price

• “Clears the market” neither a surplus nor a shortage at the end of the trading period

• Economic Model of the market – CANNOT know how long it will take to reach

• Price is set TOO HIGH the surplus will tend to force price down

• Price is set TOO LOW the shortage will ten to force price up

Explaining and Predicting Prices

• A change in price is the result of a – Change in Supply – Change in Demand – Or BOTH

• Elasticity of Demand is also important when predicting prices

• What causes change of supply with Agriculture? – Answer: ____________________________

• See figure 6.3 – SS = curve the farmer predicted – S1S1 = curve would move to if there was a record

harvest – S2S2 = curve would move to if there was bad weather

• Food is INELASTIC a small change in supply = large change in PRICE

Explaining and Predicting Prices: Change in Supply

Figure 6.3aFigure 6.3a

Change in Supply

• Demand curve is MORE elastic • When a given change in supply occurs with an

INELASTIC demand curve – PRICES change dramatically

• When a change in supply occurs with an ELASTIC demand curve– Price change is smaller

• BOTH supply and demand are INELASTIC = wider change in price

• BOTH supply and demand are ELASTIC = less change in price

Explaining and Predicting Prices: Importance of Elasticity

Figure 6.3bFigure 6.3b

Importance of Elasticity

• Changes in income, taxes, prices of related goods, expectations, and number of consumers

• Example: GOLD

Explaining and Predicting Prices: Change in Demand

Figure 6.4Figure 6.4

The Competitive Price Theory

• The theory of competitive pricing represents a set of ideal conditions and outcomes; it serves as a model to measure market performance

• Competitive market allocates resources efficiently

• To be competitive:– Sellers are forced to lower prices – Find ways to keep cost down

• Competition among buyers keeps prices from falling TOO far

1. In a competitive market, the adjustment process moves toward market A. Equilibrium B. Surplus C. Shortage D. Model

2. If there is a shortage in a market, the price is likely to A. Increase B. Decrease C. Remain the same D. Fluctuate

3. If there is a surplus in a market, the price is likely to A. Increase B. DecreaseC. Remain the same D. Fluctuate

4. The theory of competitive pricing represents A. A model by which to measure the performance of other less competitive markets B. An important theory in economics C. A set of ideal conditions and outcomes D. All of the above

5. An economic model is described by all of the following except:A. It is a set of assumptions that can be listed in a table, illustrated with a graph, or

even stated algebraically B. It can be used to help analyze behavior C. It can be used to predict outcomes D. It is usually so complex that is can be understood by economists

Jump Start Chapter 6 section 2