Prices
&
Decision Making
Advantages of Prices
• Prices link producers and consumers
• prices in a competitive market economy favor
neither the producer or consumer
– Prices are a result of competition between producers
• Prices in a market economy are flexible
– Major events can change prices
– New technology can change prices
• Prices have no cost of administration
– Prices happen without outside help or interference
– Even when prices change, most people don’t notice
because it is gradual.
Prices as a System
• As long as we have a pricing
system we have a way to
allocate resources
• We don’t have to ration or
barter
• In a competitive market, we
have a market equilibrium
= situations where prices
are relatively stable, and
supply of goods and
services is equal to the
demand
• Surplus = situation where the quantity supplied is
greater than the quantity demanded
– Surplus turns up as unsold products on shelves and takes
up space in suppliers warehouses
– Sellers then figure out their prices are too high and have to
lower the price to get rid of the surplus
• Shortage = a situation in which the quantity
demanded is greater than the quantity supplied at a
given price
– Producers have no more to sell and wish they had charged
more for their product
– As a result, both price and quantity supplied will go up
next time
• Equilibrium price = the price that “clears the market”
by leaving neither a surplus or shortage at the end of
the trading period
– When price is too high, the surplus will tend to force it
down
– When price is too low, the shortage tends to force it up
– As a result, the market tends to seek its own equilibrium.
Explaining and Predicting Prices
• Change in price is normally a result of a change in
supply, a change in demand, or changes in both
– Changes in Supply:
• Example: agriculture experiences big swings in prices
• Weather can change the supply, and therefore the price
– Changes in Demand:
• Changes in income, tastes, prices of related products, expectations, and
number of consumers all affect demand for goods and services
– Example: gold prices have changed dramatically over the last 20 years
– 1980, rising prices, uncertain economic conditions, etc. created high
demand for gold
– So gold producers opened closed mines and resumed production
– This increased the supply and drove the price of gold down