CHAPTER 6

PRICES AND DECISION MAKING

6.1 “Prices as Signals”

What do the following have in common?

TRAFFIC LIGHTS

PAIN

CAR BLINKERS

THEY ARE SIGNALS

HOW ARE PRICES USED AS SIGNALS?

•High prices – PRODUCE MORE, BUY LESS•Low prices – BUY MORE, PRODUCE LESS

Prices help perform the ALLOCATION function in a market economy (m.e.). HOW? 1. Prices in a m.e. are neutral.

Producer or consumer is NOT favored Prices result from competition between buyers and

sellers and are a compromise that both sides can live with.

2. Prices in a m.e. are flexible. Can prices adjust to unforeseen events such as

natural disasters and war? Price flexibility allows the m.e. to accommodate

change. POR EJEMPLO…

Prices help perform the ALLOCATION function in a market economy (m.e.). HOW? 3. Prices have no cost of administration.

Competitive markets don’t need no help finding their prices.

4. Prices are familiar and easily understood. People grew up with them.

WHAT WOULD LIFE BE LIKE WITHOUT A PRICE SYSTEM?

One non-price system:RATIONING See definition When might rationing be used?

COMMAND ECONOMIES WAR TIME

Benefits? Problems? Some problems

Fairness/perceived fairness High administrative cost Diminishing incentive

Book summary: Rationing is bad.

Book quote: “As long as we have prices, goods can be allocated through a system that is neutral, flexible, efficient, and easily understood by all.”

p. 140

Other effects of prices What do you notice in these charts?

How might the increase in oil prices affect the car market?

Large cars suffer, more fuel-efficient ones benefit Recent example – Saturn’s SUVs

In late 1970s, automakers thought increase in prices would be temporary, so few switched to more fuel-efficient cars

As time passed, a surplus of unsold cars remained. How did car companies adjust?

Reducing large car production, closing plants, laying off workers REBATES

What are they? Why are rebates better for companies than a flat discount? http://www.pvrwire.com/2005/11/28/tivo-saved-5-million-from-unredeemed-r

ebates/ http://www.consumeraffairs.com/consumerism/rebate_madness01.html

Oil Prices Oct 2006-Mar 2009 (estimates)

REALITY: OIL AS OF OCT 22 2008 WAS $66/BARREL