Price and Decision
Making
Chapter 6
Price
O The monetary value of
a product as
established by supply
and demand. It is a
signal that helps make
our economic
decisions.
Advantages of prices
O Prices are neutral because they do not favor
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the buyer or the consumer.
They are a result of competition.
Prices are flexible, allowing for the shocks of
unforeseen events and changes in the
market.
Prices have no administration costs.
Prices are familiar and easily understood.
Allocations without prices
O Such as the early 1970’s gas prices or
during World War II.
O Rationing, or the system where the
government decides everyone’s “fair” share,
leads to the question of fairness.
O Rationing leads to high administrative costs.
O Rationing leads to fewer incentives to work
and produce.
Prices as a system
O Together, prices comprise a system that
helps buyers and sellers allocate resources
between markets, linking all markets in the
economy.
Price adjustment process
O Together, demand and supply make a
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complete picture of the market.
Price adjustments help a competitive market
reach market equilibrium, with fairly equal
supply and demand.
Surpluses occur when supply exceeds
demand.
Shortages occur when demand exceeds
supply.
Equilibrium price is the price at which supply
meets demand.
Competitive Price Theory
O The theory of competitive pricing
represents a set of ideal conditions and
outcomes; it serves as a model to
measure market performance.
O In theory, a competitive market allocates
resources efficiently.
O To be competitive, sellers are forced to
lower prices, which makes them find
ways to keep their costs down.
O Competition among buyers keeps prices
from falling too far.
Rationing
O Rationing- An alternative to the price system.
Supply and pricing are controlled.
O Ration coupon- A ticket that lets the ticket
holder obtain certain amount of a product.
This creates a high administrative cost.
Market Equilibrium
O A situation in which prices are relatively stable and the
quantity of goods and services supplied is equal to the
quantity demanded.
Surplus
O A situation in which the quantity supplied is
greater than the quantity demanded at a
given price.
Shortage
O A situation in which the quantity demanded
is greater than the quantity supplied at a
given price.
Rebate
O A partial refund of the original price of a
product.
O There is a new trend of using debit cards as
rebates
O Is this sneaky?
Distorting Market Outcomes
O Achieving equity and security usually
requires policies that distort market
outcomes.
O One way to achieve these goals is to set
“socially desirable” prices, which interferes
with the pricing system.
Price Ceiling
O A maximum legal price that can be charged
for a product.
O Example: Rent controls on apartments in big
cities. The government can set a price
ceiling, or maximum rent.
Price Floor
O The lowest legal price that can be paid for a
good or service.
O Minimum wage is a great example.
Health care around the world
relative to price
O Japan
O The price book for services
O What kind of price control is this?
O Switzerland
O Pharmaceutical companies must negotiate with the
government to control prices
O What kind of price control is this?
O United Kingdom
O Higher taxes, yet no medical bills
When markets talk
O Markets “talk” when prices move up or down
dramatically.
O Buyers and sellers respond to changes in
the market through their decisions.
O Think of the last item you decided not to buy.
What message did your decision send to the
manufacturer?