Bellringer

• Many companies sell different types of cell phones. Some consumers prefer to use a specific brand because of its different kind of features. This is an example of

• A) monopoly.• B) oligopoly.• C) pure competition.• D) monopolistic competition.

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

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)

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

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

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 dodoctor bills, etc.

– positive externality• Examples=immunizations, historical preservation

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

Determining Prices

• Market Equilibrium– when quantity supplied equals quantity

demanded for a product equal at the same timea.k.a. “market clearing price”

• Graph:

Determining Prices

• Surplus– quantity supplied exceeds quantity demanded– producers lower prices to try to gain equilibrium

• Graph:

Determining Prices

• Shortage– quantity demanded exceeds quantity supplied– producers raise prices

• Graph:

P

Q

S

D

P

Q

D1

P1

Q1

Increase in demand

Increase in supply

S

Q1

Quantitywill definitelyincrease.

Price isIndeterminate

It will eithergo up.

P1

PS

D

P

Q

D1

P1

Q1

Increase in demand

Increase in supply

S

Q1

Quantitywill definitelyincrease.

Price isIndeterminate

It stayed thesame.

P1

PS

D

P

Q

D1

P1

Q1

Increase in demand

Increase in supply

S

Q1

Quantitywill definitelyincrease.

Price isIndeterminate

It went down.

P1

What happens to the price and quantity if thereis an increase in demand and a decrease in supply?

Price definitely goes up; Quantity is indeterminate

What happens to the price and quantity if thereis a decrease in demand and an increase in supply?

Price definitely goes down; Quantity is indeterminate

What happens to the price and quantity if thereis a decrease in demand and an decrease in supply?

Price is indeterminate; Quantity will definitely decrease

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

Setting Prices

• Price Ceiling (binding and non-binding)

• Price Floor (binding and non-binding)

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

Consequences of Setting Prices

• Rationing– gov’t decides the distribution of a product instead

of price– E.g., UGA football tickets

Consequences of Rationing

• Unfairness– rationing favors certain groups of people, while

the price system is neutral

Consequences of Rationing

• Cost– gov’t must determine what and how much is

rationed, and then enforce it

Consequences of Rationing

• Black Markets– goods exchanged illegally– defeats the purpose of rationing

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

Price Gouging

• Stossel Video