DETERMINING PRICES
Ch. 6
12.2.4
Students explain how prices reflect the relative scarcity of goods and services and
perform the allocative function in a market economy.
12.2.6
Students describe the effect of price controls on buyers and sellers
There are 2 known ways to
allocate goods and services:
The Price system and Rationing.
ADVANTAGES OF PRICES
• Prices are neutral (don’t favor buyers or
sellers)
• Prices are flexible (natural disasters, wars, can
effect prices)
• No administrative cost for prices (no individual
is responsible, no salaries, pay)
• Prices are familiar, and easily understood (had
them all of our lives, and before)
RATIONING
• A system where the government decides
everyone’s fair share. (Done usually when
resources are scarce)
• Rationing coupons are issued, which entitles you
to receive a limited amount of a product. (gas,
milk, bread, meat, etc.) [Communism/Socialism]
• Rationing was used during both World Wars, the
1970’s and 2012 Hurricane Sandy gas shortages.
DISADVANTAGE OF RATIONING
• Fairness - everyone feels their share is too
small.
• High administrative costs (printing coupons,
salaries for distributors, counterfeiting)
• Diminished incentive to work (why work
harder? Get the same)
[Communism/Socialism criticism]
PROBLEM WITH DETERMINING PRICES
• Consumers demand products at low prices,
but sellers want to sell products at high
prices…this causes a problem for the seller
when determining the price for a product.
• If the seller issues a price too high, this will cause
a surplus – supply exceeds demand. When there
is a surplus, sellers try to get rid of the product
and make some money back by: 1. Having sales,
2. Offer rebates- discounts off original price.
• If the seller issues a price too low, this will cause a
shortage – demand exceeds supply. This is not
good business!
• The sellers’ most profitable price would be at
market equilibrium – demand and supply are
equal. As prices get closer to the market
equilibrium price, there will be less shortage and
or surplus. MQ happens where the demand and
supply curves intersect.
PRICE CURVES
P
SURPLUS
30
25
MARKET EQUILIBRIUM
20
15
SHORTAGE
10
5
0
100
ANY PRICE ABOVE MQ
= SURPLUS
ANY PRICE BELOW MQ
= SHORTAGE
200
300
Q
PRICE CONTROLS
• Price ceilings- maximum legal price that can be
charged for a product. (Favors consumers, but
causes shortages!)
• Price floors – lowest legal price that can be paid
for a good or service. (Favors sellers, they do not
have to lower prices beyond that point.)
• Minimum wage – lowest legal wage that can be
paid to workers, is a price floor, but it causes job
shortages. Why? (Think about employers)