Prices as Signals• Price is a signal, giving information to buyers and sellers. – High prices—buyers buy less and producers produce more. – Low prices—buyers buy more and producers produce less.
Advantages of Prices Prices help the economy run smoothly by providing a good way to allocate resources.
Advantages of Prices (cont.)• Prices help consumers and producers make decisions on WHAT, HOW, and FOR WHOM: – In a competitive market, prices are neutral. – Prices in a market economy are flexible. The Global Economy & YOU Average Laptop Prices
Advantages of Prices (cont.)– Prices are familiar and easy to understand.– Prices have no cost of administration. The Global Economy & YOU Average Laptop Prices
Allocations Without Prices Rationing has disadvantages that are not present in the price system.
Allocations Without Prices (cont.)• Without a price system, a rationing system might be used.• Individuals receive a ration coupon to obtain a product.
Allocations Without Prices (cont.)• Problems with rationing – Difficult to allocate in fair way – Administrative cost of rationing – Negative incentive to produce
Allocation of Resources Prices are signals thathelp buyers and sellers make economic decisions.Without prices, societies must find other ways toallocate resources.
Prices as a System Prices connect all markets in an economy.
Prices as a System (cont.)• Prices help individuals make decisions and serve as signals in allocating resources between markets. – Higher oil prices have affected producer and consumer decisions. – Oil is inelastic; higher costs leave individuals with less to spend.
Prices as a System (cont.)– SUV sales dropped; manufacturers offered a rebate.– Manufacturers reduced production, closed plants, laid off workers.– Employees find jobs in new industries.
Market EquilibriumWhen buyers andsellers can freelymake production andpurchase decisions,the price of a productwill move towardmarket equilibrium. Atthis point, the quantitysupplied is exactlyequal to the quantitydemanded.
Prices as a System (cont.)• The adjustment process was a natural and necessary shift of resources for a market economy. Profiles in Economics: Margaret (Meg) Whitman
Section PreviewIn this section, you will learn how economicmodels help us understand prices in competitivemarkets.
The Price Adjustment Process In a market economy, prices seek their own equilibrium.
The Price Adjustment Process (cont.)• Transactions in a market economy are voluntary, so compromises between buyers and sellers must benefit both.• An economic model is used to analyze behavior and predict outcomes.
The Price Adjustment Process (cont.)• Supply and demand curves intersect to form the equilibrium price. – A surplus is any unsold product on store shelves or in warehouses. – Sellers lower prices to attract more buyers. Market Equilibrium
The Price Adjustment Process (cont.) – A shortage exists when supply does not meet demand. – Prices and quantities will go up to meet demand. Surpluses and Shortages
The Price Adjustment Process (cont.)• When the equilibrium price is found, there is no shortage or surplus during the market period.• Factors may come along to disturb the equilibrium price, then shortages and surpluses will appear again to find a new equilibrium level. Surpluses and Shortages
Explaining and Predicting Prices Changes in supply and demand can result in changes in prices.
Explaining and Predicting Prices (cont.)• A change in price is normally caused by – A change in supply – A change in demand – A change in supply and demand Changes in Prices
Explaining and Predicting Prices (cont.)• Predictions can be made if we know the elasticity of each curve and the underlying factors that cause the supply and demand curves to change.• A competitive market is one that “runs itself,” finding its own equilibrium.• Questions of WHAT, HOW, and FOR WHOM are decided by the buyers and sellers.
Section PreviewIn this section, you will learn that governmentssometimes use policies that interfere with themarket in order to achieve social goals.
Distorting Market Outcomes Price ceilings and price floors prevent prices from allocating goods and resources.
Distorting Market Outcomes (cont.)• Sometimes the price system cannot accurately inform buyers and sellers in the market.
Distorting Market Outcomes (cont.)• Price ceiling advantages – Some individuals are happy. – Individuals who could not afford the market price not may be eligible. Price Ceilings
Distorting Market Outcomes (cont.)• Price ceiling disadvantages – Demand becomes too high. – Suppliers face lower profits. – Suppliers limit service or leave market altogether. Price Ceilings
Distorting Market Outcomes (cont.) • Price floor Price Ceilings – Minimum wage is an example.1. The BIG Idea Explain why a governmentwould consider imposing a price ceiling orprice floor.2. Analyzing Visuals Look at Figure 6.4 on Price Floorsp. 157. How does the price ceiling affect therelationship between quantity supplied andquantity demanded? Why does the priceceiling make this relationship permanent?
Agricultural Price Supports Government programs to help stabilize prices for farmers have both positive and negative effects.
Agricultural Price Supports (cont.)• During the Great Depression of the 1930s, farm prices fell much further than other prices in the economy.• Federal government established the Commodity Credit Corporation (CCC) to help farmers.
Agricultural Price Supports (cont.)• Under the CCC support programs – A target price was established to help stabilize farm prices. – Loan supports like the nonrecourse loan were available. – Farmers received a deficiency payment. Deficiency Payments
Agricultural Price Supports (cont.)• Agricultural output increased greatly over time, as did the number of farmers.• Government wanted farmers to stop farming—the Conservation Reserve Program of 1985 pays farmers not to farm.
Agricultural Price Supports (cont.)• Efforts to make farming responsive to the market forces of supply and demand continue today with the Farm Security and Rural Investment Act of 2002.3. Explaining Why did the federal governmentestablish agricultural price support programs?4. Predicting What would happen if thegovernment eliminated all farm subsidies?5. Deciding Should the government eliminate allfarm subsidies? Explain your reasoning.
When Markets Talk Markets send signals when prices change in response to events.
When Markets Talk (cont.)• Markets bring buyers and sellers together.• Markets are said to “talk” when prices in them move up or down significantly in reaction to events that take place elsewhere in the economy.
Social Goals and Prices The social goals of equityand security sometimes can be achieved only bygiving up parts of other goals. Price ceilings or pricefloors can help achieve these goals, but they mayresult in fewer goods and services offered overall.