Prices and Decision Making

1
Prices and Decision Making

• Chapter 6

2
Prices as Signals

• Section 1

3
Advantages of Prices

• Prices are neutral because they do not favor the
  buyer or the consumer. They are the result of
  competition.
• Prices are flexible, allowing for the shocks of
  unforeseen events and changes in the market.
• Prices have no administration costs.
• Prices are familiar and easily understood.

4
Discussion Question

• In your opinion, why does the neutrality of
  prices stimulate competition?

5
Allocations Without Prices

• Rationing, or the system where the government
  decides everyones fair share, leads to the
  question of fairness.
• Rationing leads to high administrative costs.
• Rationing leads to fewer incentives to work and
  produce.

6
Discussion Question

• Imagine that no matter how much you studied, you
  already knew you were going to get a B in
  Economics. How would this affect your incentive
  to study?

7
Prices as a System

• Together, prices comprise a system that helps
  buyers and sellers allocate resources between
  markets, linking all markets in the economy.

8
Discussion Question

• Why do you think rebates were not enough to
  reenergize the big-car market during the 1970s
  energy crisis?

9
The Price System at Work

• Section 2

10
The Price Adjustment Process

• Price adjustments help a competitive market reach
  market equilibrium, with fairly equal supply and
  demand.
• Surpluses occur when supply exceeds demand.
• Shortages occur when demand exceeds supply.
• The equilibrium price is the price at which
  supply meets demand.

11
Discussion Question

• Imagine that you want to go to a concert but you
  find it is sold out at ticket outlets. What
  effect will this shortage of tickets have on the
  price of any remaining concert tickets?

12
Explaining and Predicting Prices

• A change in price is normally the result of a
  change in supply, a change in demand, or both.
• Even small changes in an inelastic supply can
  create big changes in price.
• Elastic supply and demand help keep prices from
  changing dramatically.

13
Discussion Question

• U.S. soybean farmers had a record-high harvest in
  1998. What likely effect did the increase in the
  supply of soybeans have on their price?

14
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.
• In theory, a competitive market allocates
  resources efficiently.
• To be competitive, sellers are forced to lower
  prices, which makes them find ways to keep their
  const down.
• Competition among buyers keeps prices from
  falling too far.

15
Discussion Question

• Why do experts say that a market economy is one
  that runs itself?

16
Social Goals vs. Market Efficiency

• Section 3

17
Distorting Market Outcomes

• Achieving equity and security (two of the seven
  broad economic and social goals) usually requires
  policies that distort market outcomes.
• One way to achieve these goals is to set
  socially desirable prices, which interferes
  with the pricing system.
• Setting price ceilings affects the allocation of
  resources.
• The minimum wage is an example of a price floor.

18
Discussion Question

• Do you agree with economists who argue that the
  minimum wage actually contributes to unemployment
  rates? Why or why not?

19
Agricultural Price Supports

• Government loan support was offered in the 1930s
  through the Commodity Credit Corporation to help
  stabilize agricultural prices. The CCC loan
  program led to food surpluses.
• The CCC switched to deficiency payments, which
  prevented the government from holding surplus
  food and had farmers sell their crops on the open
  market.
• In 1996, Congress passed FAIR-Federal
  Agricultural Improvement and Reform Act. Cash
  payments replace price supports and deficiency
  payments. The payments ended up costing as much.
  In 2002, farmers will no longer receive any kind
  of payments.

20
Discussion Question

• In your opinion, which kind of price support
  provides farmers with the most incentive to sell
  their crops at the highest possible price?

21
When Markets Talk

• Markets talk when prices move up or down
  dramatically.
• Buyers and sellers respond to changes in the
  market through their decisions.

22
Discussion Question

• Think or the last item you decided not to buy.
  What message did your decision send to the
  manufacturer?