2. Prices in the Free
Market
Help move land, labor, and capital into
the hands of producers and finished
goods into the hands of consumers.
Can vary for many reasons.
– Help consumers decide what to buy.
– Example
3. Advantages of Prices
Incentives
– Can be signals to producers or
consumers to adjust.
– Can tell people if goods are in short
supply or easily available.
– Traffic Light Example
Producers Consumers
Green – High Price Green – Low Price
4. Advantages of Prices
(Cont.)
Flexibility
– Prices can be adjusted when a supply or
demand shift changes equilibrium.
This is because prices are easier to adjust
than output levels.
Supply Shock or Shortage.
– Increasing supply can be time consuming and
difficult.
– Rationing is expensive and hard to organize.
– Raising prices solves this problem.
5. Advantages of Prices
(Cont.)
Price System is Free
– Unlike central planning.
– Everyone is familiar with them which
allows goods to flow through an economy
without a central plan.
– Allows for there to be a wide variety of
choices available to the population.
– Price system allows resources to
be allocated efficiently.
6. Rationing and Shortages
Rationing is expensive and difficult to
organize but has been used by the U.S.
before.
– WWII – Chosen because a price based system
may have put necessities beyond the means of
many Americans.
– Created a “Black Market”
When consumers pay more for a good that rationing
would make otherwise unavailable.
Illegal and largely discouraged by governments.
7. Prices and the Profit Incentive
Adam Smith “Wealth of Nations”
– Producers do not provide goods out of
the kindness of their hearts, they do it
because they want to make a profit.
8. Market Problems
Imperfect Competition
– If only a few firms are selling a product there
might not be enough competition among sellers
to lower the market price down to the cost of
production.
Externalities
Imperfect Information
– If people do not have enough information about
a product they may not make informed choices
that are beneficial to them.
