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Prices

Prices. The Language of Prices. Prices are the main form of communication b/n producers and consumers in a market Model of Pricing—its not just what it’s worth “What is it worth? To whom? At what time? In what context? In relation to what other goods?—Ludwig von Mises.

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Prices

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  1. Prices

  2. The Language of Prices • Prices are the main form of communication b/n producers and consumers in a market • Model of Pricing—its not just what it’s worth • “What is it worth? To whom? At what time? In what context? In relation to what other goods?—Ludwig von Mises

  3. Benefits of the Price System • Information • prices give producers an idea of demand and what they should produce • consumers use prices to gauge the relative worth of a good • Incentives • profit motive • producers and consumers have incentives at the varying prices (law of supply and demand)

  4. Benefits of the Price System • Choice • the higher the incentive to supply, the greater the choice of product supplied • the more demand, the more choices as suppliers look to generate more sales from more people • Efficiency • prices cause a wise use of resources as businesses look to make higher profits • quickly conveys the value of a good, thus saving the consumer time • Flexibility • one of the price system’s greatest strengths is ability to deal with change

  5. Limitations of the Price System • Market Failures • limitations are often referred to as market failures b/c the market fails to account for some costs and therefore cannot distribute them appropriately

  6. Limitations of the Price System • Externalities • side effects that result from the production of a good on people not directly connected with its production or consumption • considered costs of production as well, but are paid by other people and not included in the price of goods • negative externality • E.g., air pollution=GA Power • they don’t have to pay, we dodoctor bills, etc. • positive externality • Examples=immunizations, historical preservation

  7. Limitations of the Price System • Public goods • cost is not assigned to all customers unless required by gov’t • if the gov’t didn’t require all to pay through taxes, some would be unwilling to do so, even though everyone benefits • costs of public goods often more than benefits, but usually go unnoticed b/c it is spread over so many people • Instability • although flexibility is good, it can create havoc when prices increase or decrease in short amounts of time

  8. Determining Prices • Market Equilibrium • when quantity supplied equals quantity demanded for a product equal at the same timea.k.a. “market clearing price” • Graph:

  9. Determining Prices • Surplus • quantity supplied exceeds quantity demanded • producers lower prices to try to gain equilibrium • Graph:

  10. Determining Prices • Shortage • quantity demanded exceeds quantity supplied • producers raise prices • Graph:

  11. Shifts in both Supply and Demand What happens to Price and what happens to Quantity?

  12. P S S Quantity will definitely increase. P1 P1 P D1 Price is Indeterminate D It will either go up. Q Q1 Q1 Q Increase in demand Increase in supply

  13. P S S Quantity will definitely increase. P1 P P1 D1 Price is Indeterminate D It stayed the same. Q Q1 Q1 Increase in demand Increase in supply

  14. P S Quantity will definitely increase. P1 S P P1 D1 Price is Indeterminate D It went down. Q Q1 Q1 Increase in demand Increase in supply

  15. What happens to the price and quantity if there is an increase in demand and a decrease in supply? Price definitely goes up; Quantity is indeterminate

  16. What happens to the price and quantity if there is a decrease in demand and an increase in supply? Price definitely goes down; Quantity is indeterminate

  17. What happens to the price and quantity if there is a decrease in demand and an decrease in supply? Price is indeterminate; Quantity will definitely decrease

  18. Managing Prices • The gov’t will sometimes choose to set prices and ration goods to try to keep the market functioning smoothly and avoid instability caused by dramatic price swings

  19. Setting Prices • Price Ceiling (binding and non-binding) • Price Floor (binding and non-binding)

  20. Consequences of Setting Prices • Most economist advise against gov’t interferences in the market that cause imbalances, etc. • price ceilings=shortages • price floors=surpluses • E.g., look at rent controls and crop prices in Sowell book

  21. Consequences of Setting Prices • Rationing • gov’tdecides the distribution of a product instead of price • E.g., UGA football tickets

  22. Consequences of Rationing • Unfairness • rationing favors certain groups of people, while the price system is neutral

  23. Consequences of Rationing • Cost • gov’t must determine what and how much is rationed, and then enforce it

  24. Consequences of Rationing • Black Markets • goods exchanged illegally • defeats the purpose of rationing

  25. Taxes • Who bears the burden when taxes are passed? • Tax incidence • the manner in which the burden of a tax is shared among market participants • We will look at this in-depth in the next two chapters, as well as how elasticity effects tax incidence

  26. Price Gouging • Stossel Video

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