Prices and Decision Prices and Decision MakingMakingChapter 6Chapter 6

Goals & ObjectivesGoals & Objectives

1. Prices as Signals in the marketplace.

2. Prices & allocation of resources.

3. Scarcity without prices: Communism

4. Prices in competitive markets.

5. Price changes and influencing factors.

6. Elasticity and price changes.

7. Fixed prices and market shortages.

8. Loan supports, deficiency payments, target prices: Gov’t involvement.

Prices as Signals in the Prices as Signals in the MarketMarket

Monetary value Monetary value of a product of a product established by supply and demand in established by supply and demand in the marketplace.the marketplace.

1. 1. SubsidiesSubsidies effects: effects:

2. 2. EntitlementEntitlement effects: effects:

3. 3. RegulationRegulation effects: effects:

4. 4. MonopolyMonopoly effects: effects:

Provide examples for each.Provide examples for each.

Dairy SubsidiesDairy Subsidies

Advantages of PricesAdvantages of Prices

1.1. Serve as a link Serve as a link between Consumers between Consumers and Producers. and Producers.

Prices determine: What, How, and For Prices determine: What, How, and For Whom to ProduceWhom to Produce

Gov’t Regulation & Gas PricesGov’t Regulation & Gas Prices

Advantages of PricesAdvantages of Prices

2. 2. Prices are neutral Prices are neutral (Competitive (Competitive Market).Market). They favor neither the producer or They favor neither the producer or

consumerconsumer Willing seller & a willing buyerWilling seller & a willing buyer

Explain how government subsidies Explain how government subsidies affect prices in the short and long run.affect prices in the short and long run.

Subsidies & Iron TrianglesSubsidies & Iron Triangles

Advantages of PricesAdvantages of Prices

3. 3. Prices are flexible Prices are flexible (Market (Market Economy)Economy)

Explain how government regulations Explain how government regulations affect flexible prices: Fads, Fashions, affect flexible prices: Fads, Fashions, trends Natural Disasters, profit motivestrends Natural Disasters, profit motives

Price Gouging Laws & Price Gouging Laws & ShortagesShortages

Advantages of PricesAdvantages of Prices

4. 4. Prices have no administrative Prices have no administrative costs or tax base needs from the costs or tax base needs from the marketplacemarketplace

Fewer GovFewer Gov’’t employees to determine: t employees to determine: What, How and For Whom To ProduceWhat, How and For Whom To Produce

Example: Social Security, Welfare, Food Stamps, Example: Social Security, Welfare, Food Stamps, Regulation of Indian Affairs, etc…Regulation of Indian Affairs, etc…

Taxes are Administrative Taxes are Administrative CostsCosts

Advantages of PricesAdvantages of Prices

5. 5. Prices are familiar and easily Prices are familiar and easily understood understood by mostby most

1. Minimum wage requirements and 1. Minimum wage requirements and price offsets. Explain: Price-Wage price offsets. Explain: Price-Wage Spiral.Spiral.

2. Obamacare and market-prices?2. Obamacare and market-prices?

3. Oil & gasoline prices and 3. Oil & gasoline prices and government regulation?government regulation?

Health Insurance RegulationHealth Insurance Regulation

Allocations without PricesAllocations without Prices

1.1. Without prices; Who decides who Without prices; Who decides who gets what, how and for whom to gets what, how and for whom to produce? produce? Government Government allocatesallocates, , rationsrations, , redistributes redistributes wealth wealth by answering the For Whom by answering the For Whom To Produce question. To Produce question.

1. 1. rationing couponrationing coupon: Food Stamps: Food Stamps Government deciding Government deciding ““everyones fair shareeveryones fair share””

Wealth Redistribution by RationingWealth Redistribution by Rationing

The Problem of FairnessThe Problem of Fairness

1. 1. High Administrative CostsHigh Administrative Costs: : Bureaucracy and TaxesBureaucracy and Taxes

2. 2. Diminished IncentiveDiminished Incentive: Why be : Why be productive if your needs are provided for productive if your needs are provided for by taxpayers. (Unemployment by taxpayers. (Unemployment Compensation Insurance, Welfare, Food Compensation Insurance, Welfare, Food Stamps, Housing, Obamacare)Stamps, Housing, Obamacare)

Unemployment & Unemployment & Diminished IncentiveDiminished Incentive

Prices as a SystemPrices as a System

Prices serve as signals.Prices serve as signals.• 1. 1. Higher oil prices in the 1970Higher oil prices in the 1970’’s led to: s led to:

A. smaller automobiles more fuel efficientA. smaller automobiles more fuel efficient B. Carpooling to work B. Carpooling to work C. New technology in the auto industryC. New technology in the auto industry

• 2. Lower oil prices in the 1990’s led to a 2. Lower oil prices in the 1990’s led to a booming consumer economy. Why?booming consumer economy. Why?

• 3. How would cheap gasoline affect green 3. How would cheap gasoline affect green energy prices and demand for green energy energy prices and demand for green energy products?products?

RebatesRebates

What is a What is a rebaterebate??

• A partial refund of the original price.A partial refund of the original price.

• Why offer? Competitive advantage over Why offer? Competitive advantage over smaller retailer/whole-sellers.smaller retailer/whole-sellers.

• Who Benefits? Consumer and Retailer.Who Benefits? Consumer and Retailer.

Milton FriedmanMilton Friedman

Capitalism and FreedomCapitalism and Freedom 1. Agricultural subsidies?1. Agricultural subsidies? 2. Price controls?2. Price controls? 3. Minimum Wage Requirements?3. Minimum Wage Requirements? 4. Federal Reserve System?4. Federal Reserve System?

The Price System at WorkThe Price System at Work

Market EquilibriumMarket Equilibrium: Market Price: Market Price Supply and Demand curve cross.Supply and Demand curve cross.

1. 1. SurplusSurplus: quantity supplied is : quantity supplied is greater than the quantity demanded greater than the quantity demanded JIC TheoryJIC Theory

2. 2. ShortageShortage: quantity supplied is : quantity supplied is less than the quantity demanded. JIT less than the quantity demanded. JIT TheoryTheory

Surplus & ShortageSurplus & Shortage

Explaining Market PricesExplaining Market Prices

Causes in Causes in Supply ChangeSupply Change: Expectations: Expectations

Causes in Causes in Demand ChangeDemand Change: Fads, Trends: Fads, Trends

A A Competitive Price TheoryCompetitive Price Theory: the : the market runs itself without gov’t market runs itself without gov’t interference. interference.

Distorting Market OutcomesDistorting Market Outcomes

Social GoalsSocial Goals: Gov’t setting prices at : Gov’t setting prices at “socially desirable” levels.“socially desirable” levels.

Marketplace Effects of Social Goals: Marketplace Effects of Social Goals: 1.1. Medicaid: 50% doctors do not accept; Trillion dollars in Tax Medicaid: 50% doctors do not accept; Trillion dollars in Tax

RevenueRevenue

2.2. Medicare: Govt decides who gets care; Trillion dollars in Tax Medicare: Govt decides who gets care; Trillion dollars in Tax RevenueRevenue

3.3. Obamacare: Govt decides who gets care; Shortage of suppliersObamacare: Govt decides who gets care; Shortage of suppliers

4.4. Food Stamps: Inflation of food prices.Food Stamps: Inflation of food prices.

5.5. HUD or Fannie Mae or Freddie Mac: Housing bubble & burst; HUD or Fannie Mae or Freddie Mac: Housing bubble & burst; deflation of housing prices; increased foreclosures.deflation of housing prices; increased foreclosures.

Medicaid & CostsMedicaid & Costs

Medicare CostsMedicare Costs

Food Stamps & CostsFood Stamps & Costs

Social Goals vs. Market Social Goals vs. Market EfficiencyEfficiency

Government goals of: Full Employment, Government goals of: Full Employment, Price Stability, Economic GrowthPrice Stability, Economic Growth

Are in competition with: Profit Motives, Are in competition with: Profit Motives, Economic Freedom, Economic EfficiencyEconomic Freedom, Economic Efficiency

Price ceilings Price ceilings and and Price floorsPrice floors::

Price Ceilings & ShortagesPrice Ceilings & Shortages

Price CeilingsPrice Ceilings

Rent ControlRent Control: Some people can not : Some people can not afford rent = Govafford rent = Gov’’t Rent controls = t Rent controls = Lessened quality of available rental Lessened quality of available rental units = Govunits = Gov’’t Regulations on rent t Regulations on rent quality = Lessened number of quality = Lessened number of available units for rent = Government available units for rent = Government built rental units!built rental units!Gov’t caused Gov’t caused ShortagesShortages

Price FloorsPrice Floors

Some people make too little money = Some people make too little money = Government Government minimum wage minimum wage requirement requirement = lessened productivity = = lessened productivity = expensive workers = more unemployed expensive workers = more unemployed persons = need for Welfare, Food persons = need for Welfare, Food Stamps, Unemployment CompensationStamps, Unemployment CompensationGov’t caused: Unemployment or Labor Gov’t caused: Unemployment or Labor ShortagesShortages

Agricultural Price SupportsAgricultural Price Supports

Commodity Credit Corporation 1930; Commodity Credit Corporation 1930; Today’s Department of Agriculture: Today’s Department of Agriculture:

Loan SupportsLoan Supports: : Nonrecourse loan:Nonrecourse loan:Effects: Effects: Surplus of Food owned by Gov’tSurplus of Food owned by Gov’t

Deficiency PaymentsDeficiency Payments: Gov’t subsidy : Gov’t subsidy for prices under target prices or profitsfor prices under target prices or profits

Target PricesTarget Prices: Govt established : Govt established wages/profits for farmers. wages/profits for farmers.

Subsidys, Surpluses, Subsidys, Surpluses, ShortagesShortages

Loan SupportsLoan Supports

Farmers receive government loans to Farmers receive government loans to grow certain crops for a guaranteed grow certain crops for a guaranteed price to the government in return.price to the government in return.

Peanuts!!! Cotton!!!Peanuts!!! Cotton!!!

Deficiency PaymentsDeficiency Payments

Result of CCC: Huge surpluses of peanuts Result of CCC: Huge surpluses of peanuts and cottonand cotton

Government sells product in market below Government sells product in market below market price. Long term affects of low market price. Long term affects of low prices equals fewer suppliers. prices equals fewer suppliers. ExampleExample: : Dairy or Milk producersDairy or Milk producers

Government allows farmer to sell product Government allows farmer to sell product and receive an additional payment for lost and receive an additional payment for lost profits.profits.

Reforming Price SupportsReforming Price Supports

FAIRFAIR– 1996-2002: Federal Agricultural – 1996-2002: Federal Agricultural Improvement and Reform: Improvement and Reform: 1.1. WinnersWinners: Big Corporate Agricultural : Big Corporate Agricultural

IndustryIndustry

2.2. LosersLosers: Private farms and family farms. : Private farms and family farms.

Gov’t caused Gov’t caused surplusessurpluses in short run. in short run.

Gov’t caused Gov’t caused shortagesshortages in the long run. in the long run.

Gov’t created Gov’t created monopoliesmonopolies..