Chapter 6 Section 3
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Help solve shortage
and surplus
problems
Tool for
distributing goods
and resources
Very efficient
◦ Centrally planned is
the alternative; it is
not efficient
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Provides a common language
Price as an incentive
◦ Prices provide incentive to both demand and supply
◦ Buyers behave to prices in a certain way; as do
suppliers (Law of Demand; Law of Supply)
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Prices as Signals
◦ Price gives
information on
production and
demand for
producers and buyers
in the market
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Flexibility
◦ Prices can easily adjust to a supply shift or a
demand shift
◦ Prices are more flexible than output levels (X-axis
of graph)
◦ Supply Shock – sudden shortage
 Increase supply – time consuming
 Rationing – system of allocating goods not using price
= expensive
 Raise prices – quickest way to alleviate shortage
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Price System is “Free”
◦ Costs nothing to administer
◦ Centrally planned takes thousands of bureaucrats
to collect info and decide how to distribute goods
and services
◦ Decisions are up to consumers and producers in
free market
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Large diversity of goods and services to
choose from
◦ Make decisions based on price (budget-based)
◦ Producers can set a target audience
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Rationing and Shortages
◦ Consumers have less choices, and have trouble
finding goods
◦ USSR, US during WWII
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Black Market
◦ Market in which goods are sold illegally, without
regard for govt. controls on price or quantity
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Efficient Resource Allocation
◦ Market system ensure that resources go to the uses
that consumers value most highly
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The Wealth of Nations by Adam Smith
◦ People prosper by finding out what people want,
and the providing it.
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Heat Wave Scenario
◦ Coming heat wave
◦ Increase demand for air conditioners and fans and
power to run them
◦ Suppliers see potential for profit with higher prices
and produce more fans and air conditioners, and
more power is produced to run them
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Market Problems
◦ Imperfect competition
 not enough firms in market
◦ Negative externalities
 side effects of productions that have unintended costs
(pollution)
◦ Imperfect information
 if buyer or sellers don’t have adequate information,
they may not make the best decision