Prices and Decision Making. Price The monetary value of a product as established by supply and...
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Transcript of Prices and Decision Making. Price The monetary value of a product as established by supply and...
Prices and Decision Making
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
The Price System at Work
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 6.1aFigure 6.1aSURPLUS= occurs
when supply EXCEEDS demand
SHORTAGE= occurs when demand
EXCEEDS supply
EQUILIBRIUM PRICE = occurs when supply
MEETS demand
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
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
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
• 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
Social Goals vs. Market Efficiency
Distorting Market Outcomes
• Seven Economic goals compatible with the market economy – Freedom– Efficiency – Full employment – Price stability – Economic growth
• Two others: Equity and Security – Usually distort market outcomes– One way to achieve these goals is to set “socially
desirable” prices, which interferes with the pricing system.
Price Ceilings
• A maximum legal price that can be charged for a product – New York City does
this with rent control to make housing more affordable.
– This can create a shortage. How?
• Affects allocation of resources
Figure 6.5aFigure 6.5a
Price Floors
• Lowest legal price that can be paid for a good or service – Minimum wage
• Lowest legal wage that can be paid to most workers
• at 7.25
– This can create a surplus. How?
Figure 6.5bFigure 6.5b
Agricultural Price Supports
• 1930’s est. Commodity Credit Corporation – Help stabilize agricultural prices– Used loan supports and deficiency payments – BOTH used target price: a price floor for farm
products
Loan Support
• Borrowed money from CCC at the target price and pledged his crops in return
• Led to food surpluses • Nonrecourse loan: a loan
that carries neither a penalty nor further obligation to repay if not paid back
Figure 6.6aFigure 6.6a
Deficiency payments
• Check sent to producers that makes up the difference between the actual market price and the target price
• Prevented the gov’t from holding surplus foods
• Had farmers sell crops on the open market
Figure 6.6bFigure 6.6b
Federal Agricultural Improvement and Reform Act (FAIR)
• Cash payments replaced price supports and deficiency payments
• Cost just as much
• 2002, farmers no longer receive any kind of payments
When Markets Talk
• Markets “talk” when prices move up or down dramatically
• Buyers and sellers respond to changes in the market through their decisions