economics chapter 6 prices and decision making. prices as signals price- the monetary value of a...
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EconomicsChapter 6
Prices and Decision Making
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Prices as Signals• Price- the monetary value of a
product as established by supply and demand- is a signal that helps us make our economic choices.
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Advantages of Prices• Link between producers and consumers
• Prices are neutral- they favor neither the producer nor the consumer
• Result of competition
• Represent a compromise both sides can live with
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Advantages of Prices• Prices in a market economy are
flexible• Unforeseen events affect prices (war)• Allows market to accommodate
change
• Prices have no administrative cost• Allows people to make decisions
quickly and efficiently with minimum of time and effect
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Allocations without Prices
• 1. without prices, another system must be used to decide who gets what
• 2. one method is RATIONING- a system under which an agency such as government decides everyone’s fair share- use a RATION COUPON
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Allocations without Prices
• 3. Problem of fairness
• 4. High Administrative Cost
• 5. Diminishing incentive
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Prices as a System• 1. prices not only help individuals in specific
markets, they serve as signals that help allocate resources between markets.
• 2. Example- • High oil prices in the ‘70s• Auto makers had to offer REBATES to get rid of
big cars• Shut down plants• Started making small fuel-efficient cars• Laid off workers who then when to work in other
industries
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Class/Homework1. Define: price, rationing, and rebate.
2. List the advantages of using prices to distribute economic products.
3. Explain the difficulties of allocating goods and services without a price system.
4. From your own experience, describe a situation that required rationing. What criteria were used to allocate the good or service, and what were some of the problems with each of the criteria?
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The Price System at Work
• Competitive market- everyone who participates has a hand in determining prices- that’s why economists consider prices neutral and impartial.
• Buyers and sellers have opposite hopes and desires.
• Sellers- hope for high prices and large profits• Buyers- want good buys at low prices.
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Price Adjustment Process
• Market Economy voluntary- compromise must benefit seller and consumer.
• 1. An economic Model- • A set of assumptions that can be
listed in a table, illustrated with a graph, or even stated algebraically- to help analyze behavior and predict outcomes.
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Price Adjustment Process
• 2. market equilibrium- situation in which prices are relatively stable, and the quantity of goods and services supplied is equal to quantity demanded.
• 3. Surplus- situation is which the quantity supplied is greater than the quantity demanded at a given price.• Prices will be reduced to get rid of the
surplus
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Price Adjustment Process
• Shortage- a situation in which the quantity demanded is greater than the quantity supplied at a given price• Price and quantity will go up in the
next trading period
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Price Adjustment Process
• Equilibrium price- • Is the price to “clear the market” by
leaving neither a surplus or shortage at the end of the trading period
• It will remain at the price until something comes along to disturb the equilibrium- them new surplus and shortages will appear
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Explaining and Predicting Prices
• 1. Changes in Supply:
• Weather has a large effect on supply, especially in agriculture
• Because both demand and supply for food is inelastic, a small change in supply is enough to cause a large change in the price.
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Explaining and Predicting Prices
• Importance of Elasticity:
• When a given change in supply is coupled with an inelastic demand curve, price changes dramatically
• When the same change in supply is coupled with a very elastic demand curve, the change in price is much smaller
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Explaining and Predicting Prices
• Changes in Demand:
• A change in demand can also affect the price of a good or service.
• Example- • gold in the 1980s • Rising prices• Uncertain economic conditions• High demand for gold
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Class/Homework• 1. Explain how a change in demand can
affect prices.
• 2. Describe how prices are determined in a competitive market.
• 3. Explain why economic models are useful.
• Do your notecards.
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Social Goals v. Market Efficiency
• Social Goals: • Freedom• Efficiency • Full employment• Price stability • Economic growth• Equity and security
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Distorting Market Outcomes
• One way to achieve social goals involves setting prices at “socially desirable” levels.
• Price ceilings • Price floors
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Distorting Market Outcomes
• Price Ceilings:
• Maximum legal price that can be charged for a product.
• Example: New York City rent• Didn’t work- landlords converted the
apartments to condos and offices. • Also quit the upkeep of the apartments
needed to reduce costs
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Distorting Market Outcomes
• Price Floors:
• Prices often considered too low and so steps are taken to keep them higher
• Example: minimum wage• Actually increases the number of people
without jobs• Some argue that minimum wage is
irrelevant anyways because it is actually lower than the lowest wages in many areas
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Agricultural Price Supports
• 1930 federal gov’t established the Commodity Credit Corporation- to help stabilize agricultural prices by way of • Loan supports• Deficiency payments
Both made use of a “target price”, which essentially is a price floor for farm products.
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Loan Supports• Farmer borrows money from CCC at
target price and pledges his crops as security in return.
• Farmer can sell crop and repay CCC or let CCC take possession of the crop.
• Nonrecourse loan- a loan that carries neither penalty nor further obligation to repay if not paid back- the farmer could at least get the target price for his crops.
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Deficiency Payments• A. CCC loan program created problems
because the Dept. of Agriculture soon had enormous stockpiles of food.
• B. Solution- have farmers sell their products for the best price then the CCC would make up the difference with deficiency payments- check sent to the producers that makes up the difference between the actual market price and target price.
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Reforming Price Supports
• 1. in 1996 Congress passed the FAIR Act.
• 2. under FAIR, cash payments take the place of price supports and deficiency payments.
• 3. by 2002, program expires• Cease to receive all payments• Farmers will be use to supply and
demand
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Class/Homework1. Describe two effects of having a fixed price
other than the equilibrium price forced on a market.
2. Explain how loan supports and deficiency payments work.
3. Would small businesses be more affected by a change in the minimum wage than large businesses. Explain your answer.
4. Do your notecards.