Price and Decision Making

Do Now!!!

• Think about a time when you bought a product that you really wanted. Was the product worth the price? Did you see the same product at a lower price? How did that make you feel?

Prices as Signals

• Price is the monetary value of a product that is established by supply and demand.

• They communicate information and provide incentives to consumers and producers.

The Advantages

• Serve as link between producers and consumers.

• They perform an allocation function for four reasons

Reasons

• They favor neither the producer nor the consumer.

• They are flexible.

• They have no cost of administration.

• They are common knowledge to consumers and producers.

Allocations w/out prices

• Rationing is used to allocate goods and services without the use of price. Has pros and cons.

• Pros– Does not need price.

• Cons– Highly unfair

– There is a high admin. Cost.

– Negative impact on motivation to work.

Price as System

• They are favored because they do more for the consumer because the provide signals that help utilize resources.

• They link all markets within the economy.

Market Event Supply or Demand

Right or Left

redwood lumber Environmentalists urge consumers to boycott redwood products.

Hula hoops Brad Pitt confides to People magazine that "he gets a big kick out of his hula hoop."

gasoline Two oil supertankers collide.

U.S. cars The U.S. imposes a tariff on Japanese car imports.

Taxi service Local subway workers go on strike

cement A 7.9 earthquake hits San Francisco.

1. What is the problem with health insurance today?

2. Why are people skeptical about using insurance?

3. How do you think we need to fix this problem?

Price Adjustment

• Because of the movement in the market (transactions), a compromise must take place to benefit all parties.

• Economic models are used to explain the changes in price.

Market Equilibrium• A situation that is

reached when prices are relatively stable. Qty. of goods supplied equals the qty. of goods demanded.

Figure 6.2dFigure 6.2d

Surpluses and Shortages

• Surplus occurs when the qty. supplied is more than qty. demanded.

Figure 6.2aFigure 6.2a

Surpluses and Shortages

• Shortages are where qty. demanded is more than the qty. supplied.

Figure 6.2bFigure 6.2b

Elasticity and Price

• Prices can change dramatically based on the elasticity of the curve.

• If the price changes and people don’t buy it, then it is time to change the price again.

Changes in supply and demand

• Changes in supply and demand affect price changes as well. The shifts of both curves will force the price to be adjusted to find equilibrium.

Competitive Price Theory

• Represents a set of ideal conditions & outcomes; it serves as a model to measure market performance.

• Competitive market allocates resources efficiently.

• To be competitive, sellers are forced to lower prices, which makes them find ways to keep their costs down.

• Competition among buyers keeps prices from falling too far.

Social Goals and Market Efficiency

• Freedom, Efficiency, full employment, price stability and Growth.

• These goals are partially responsible for increased role of govt. in our economy.

• It is important to evaluate each goal and scenario for you to form an opinion on it.

• Achieving equity and security calls for policies that distort the market.

Distorting Market Outcomes

• Setting prices at a desirable level can achieve some social goals.

• Prices are not allowed to adjust to equilibrium and the price system can’t transmit accurate information to consumers and producers.

Price Ceilings• Price ceilings are the

max. legal price that can be set for a product.

• They are well below the equilibrium price.

• Affects allocation of resources.

Figure 6.5aFigure 6.5a

Price Floors• Price Floors are the

lowest legal price that can be paid for a g/s.

• Minimum wage is an example of a price floor.

• The floor is implemented to keep the price of a product higher.

Figure 6.5bFigure 6.5b

Agricultural Price Supports

• The govt. has stepped in as a regulator to help stabilize the prices of agricultural products.

• Two types– Loan support– Deficiency payment

• Both make use of a target price to help maintain stability.

Loan Supports• Farmers borrow

money from Commodity Credit Corp. (CCC) at a target price.

• Most are nonrecourse loans.

Figure 6.6aFigure 6.6a

Deficiency Payment• Surpluses were created

because of the CCC loan program.

• Farmers sell their crops for highest price and CCC would pay deficiency payment to make up the difference.

Figure 6.6bFigure 6.6b

When the Market Talks

• The market talks when changes in prices occur. This usually happens when prices move up or down in a significant amount.

• Consumers and Producers use this information and make decisions to respond to the changes.