ECONOMICS TOPIC 3 LESSON 9

ECONOMICS TOPIC 3 LESSON 9

PRICES AT WORK

ESSENTIAL QUESTION

How do we affect the economy?

The Price System

The price system is a delicate balance of supply and demand in which consumers, producers, and sellers all play a role. 

Prices and Consumers

Consider this example: You want to buy a pair of athletic shoes, so you go to a local mall to compare prices. A discount shoe store offers low-end sneakers for $20. At other stores, you find that you can spend as little as $50 for brand-name sneakers, or more than $200 for a pair of designer basketball shoes. Basing your decision on the available supply, the price, and your demand, you buy the $50 sneakers.

Prices in a Free Market

In a free market, prices are a tool for distributing goods and resources throughout the economy. Prices are nearly always the most efficient way to allocate, or distribute, resources. Prices help move land, labor, and capital into the hands of producers and finished goods into the hands of buyers. The alternative method for distributing goods and resources, namely a centrally planned economy, is not nearly as efficient as a market system based on prices.

Multiple Choice

Identify Cause and Effect How can prices solve problems of surplus?

• Lower prices decrease quantity demanded and decrease quantity supplied..

• Lower prices increase quantity demanded and decrease quantity supplied.

• Higher prices decrease quantity demanded and increase quantity supplied.

• Higher prices increase quantity demanded and increase quantity supplied

The Benefits of the Price System

Prices provide a common language for buyers and sellers.

Prices Provide Incentives

Buyers and sellers alike look at prices to find information on a good’s demand and supply. The laws of supply and demand describe how people and firms respond to a change in prices. In these cases, prices are signals that tell producers or consumers how to adjust. Prices communicate to buyers and to sellers whether goods are in short supply or readily available.

Therefore, rising prices in a market will provide an incentive for existing firms to produce more of the goods that are in demand and will encourage new firms to enter a market.

Prices Serve as Signals

Think of prices as a traffic light. A green light means “go,” and a red light means “stop.” A relatively high price is a green light that tells producers that a specific product is in demand and that they should use their resources to produce more. New suppliers will also join the market. But a low price is a red light to producers, signaling that a good is being overproduced. In this case, low prices tell a supplier that he or she might earn higher profits by using existing resources to produce a different product.

Prices Are Responsive and Flexible

Another important aspect of prices is that they are responsive to market conditions. When a supply shift or a demand shift changes the equilibrium in a market, price and quantity supplied need to change to solve problems of too much or too little demand. 

Prices Are Responsive and Flexible

 supply shock is a sudden shortage of a good such as gasoline or wheat. A supply shock creates a shortage because suppliers can no longer meet consumer demand. The immediate problem is how to divide up the available supply among consumers.

 Rationing, a system of allocating goods and services using criteria other than price, is expensive and can take a long time to organize. Rationing is the basis of central planning, an economic system in which a central authority, rather than a free market, makes basic economic decisions for a society. 

Open Ended

World War II placed many items in high demand in the United States. Analyze Charts Why might gasoline, kerosene, and other fuels be rationed during wartime?

The Price System Is “Free”

A free market distribution system, based on prices, costs nothing to administer. Central planning, however, requires many administrators to collect information on production and decide how resources are to be distributed. I

Multiple Choice

Identify For producers and consumers all across the United States, a price of $10 has the same meaning. What advantage of prices does this represent?

• Prices provide buyers and sellers with a common set of signals.

• Prices serve as an incentive to action for buyers and sellers.

• Prices are a flexible mechanism for dealing with shifts in demand.

• Prices aid the efficient distribution of goods throughout the country.

Choice and Efficiency

One benefit of a market-based economy is the diversity of goods and services that consumers can buy. Prices help consumers choose among similar products.

Rationing and Shortages

Rationing in the United States was only a short-term hardship. Still, like rationing in the Soviet Union, it was expensive and inconvenient and left many consumers unhappy. Choices were limited, and consumers felt, rightly or wrongly, that some people fared better than others. However, rationing was chosen because a price-based system might have put food and housing out of the reach of some Americans, and the government wanted to guarantee every civilian a minimum standard of living during wartime.

The Black Market

When people conduct business without regard for government controls on price or quantity, they are said to do business on the black market. Black markets allow consumers to pay more so they can buy a product when rationing makes it otherwise unavailable. Although black markets are a nearly inevitable consequence of rationing, such trade is illegal and strongly discouraged by governments.

Efficient Resource Allocation

ll of the advantages of a free market allow prices to allocate, or distribute, resources efficiently. Efficient resource allocation means that economic resources—land, labor, and capital—will be used for their most valuable purposes. A market system, with its responsive prices, ensures that resources go to the uses that consumers value most highly. A price-based system also ensures that resource use will adjust relatively quickly to the changing demands of consumers.

Multiple Choice

Check Understanding In a free enterprise economy, as opposed to a command economy, suppliers use prices to

• limit their profits.

• respond to consumer demand.

• coordinate the bartering of goods.

• encourage the surplus production of goods

Prices and the Profit Incentive

In a free market, efficient resource allocation goes hand in hand with the profit incentive.

The Wealth of Nations

dam Smith wrote about the profit incentive in The Wealth of Nations, published in 1776. Smith explained that it is not because of charity that the baker and the butcher provide people with food. Rather, they provide bread and meat because prices are such that they profit from doing so. In other words, businesses prosper by finding out what people want and then providing it. 

Market Problems

There are some exceptions to the idea that markets lead to an efficient allocation of resources. One problem is imperfect competition: If only a few firms are selling a product, there might not be enough competition to lower market prices to the true equilibrium point. 

A second problem involves negative externalities. These are side effects of production that impose unintended costs. E

Multiple Choice

Infer What, according to Adam Smith, motivated the butcher and the baker to provide people with meat and bread?

• the gratitude they received from

• the community the need to allocate food efficiently

• the wish to serve the greater good

• the opportunity for profit

Open Ended

How do we affect the economy?