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Economics Chapter 5 – Prices as signals

Economics Chapter 5 – Prices as signals . By: Illiyah E., Irais H., Matt C., Katie W. Prices as signals. Main Idea – competitive markets and prices are important to capitalism. But WHY?. Prices. Price – the monetary value of a product as established by supply and demand.

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Economics Chapter 5 – Prices as signals

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  1. Economics Chapter 5 – Prices as signals By: Illiyah E., Irais H., Matt C., Katie W.

  2. Prices as signals • Main Idea – competitive markets and prices are important to capitalism. • But WHY?

  3. Prices • Price – the monetary value of a product as established by supply and demand. • Helps us make economic decisions • Communicate information • Provide incentives to buyers & sellers

  4. Prices • High Prices: • Producers to produce MORE • Buyers to buy LESS • Low Prices: • Producers to produce LESS • Buyers to buy MORE

  5. Advantages of Prices • Serve as link between producers & consumers • Help decide WHAT, HOW and FOR WHOM • (Questions all societies face)

  6. Advantages of Prices • Prices in a competitive market economy are: • Neutral • Flexible • Efficient • Clear

  7. Prices are NEUTRAL • Don’t favor the producers nor the consumers. • They are the result of competition between buyers & sellers. • Represent compromises that both buyers & sellers can live with • More competitive market = more efficient the price adjustment process is

  8. Prices are FLEXIBLE • In times of war and natural disasters buyers and sellers adjust their consumption & production accordingly. • Helps price system absorb unexpected “shocks” which is a strength • Allows market economy to accommodate change. • Ex. Computers

  9. Prices are EFFICIENT • Markets find their own prices because of competition. • When prices adjust, its so gradual that people hardly notice.

  10. Prices are CLEAR • They are familiar and easily understood • We have known them all our lives • Allows people to make decisions quickly & efficiently with a minimum of time & effort

  11. Allocation without prices • important because they help us make economic decisions & distribute scarce resources and products • What would happen if there weren’t price systems? • Without prices another system must be used to decide who gets what.

  12. Rationing • A system under which an agency such as gov’t decides everyone’s “fair” share. • Within rationing, people receive a ration coupon. • A ticket or a receipt that entitles the holder to obtain a certain amount of a product • Can lead to PROBLEMS

  13. Problems caused by rationing • Fairness • High administrative cost • Diminishing Incentive

  14. The Problem of Fairness • Everyone feels his or her share is too small. • Ex. Oil crisis of 1970’s. The gov’t made plans for a gas rationing program. • #1 problem was determining how to allocate the gas rationing coupons, issue of fairness was never resolved.

  15. High Administrative Cost • Cost can be a problem. • Ex. Someone has to pay for the printing and the salaries of the people who distribute the coupons. NO matter how much care is taken some coupons will be stolen, sold, or counterfeited.

  16. Diminishing Incentive • Rationing has a negative impact on people’s incentive to work and produce. • Ex. Suppose we were put on a rationing system, and given a certain amount of coupons. • How would this affect your incentive to work? • If you couldn’t get more coupons by working harder, and if you got the same amount of coupons if you worked less, you would lose incentive to work

  17. Allocation mechanisms (rationing) raise issues that don’t occur under a price allocation system. • Prices = allocated goods

  18. Prices as a system • Price systems are important because of the difficulties with non-price allocation systems • Rebate – a return of part of the original payment • Prices serve as signals that help allocate resources between markets as well as help individuals in specific markets. • Ex. An appliance store gives a customer $20 after they’ve paid $200 for a microwave oven.

  19. Questions • Give examples on how prices are signals? • Prices give signals because the price of a product can either signal buyers to buy or not, and producers to sell or not. • True or False: The 3 basic questions that all societies face are WHAT, HOW, and FOR WHOM? • True

  20. Questions • What are the problems with rationing? • The problems are fairness, high administrative cost, and diminishing incentive. • Explain the function of a rebate. • Rebate is a reduction of a price after paying the original prices. You fill out a form and mail it to the company. Your refund is then mailed to you. • What are the 4 advantages of prices? • They are neutral, flexible, efficient, and clear.

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