Setting Prices
• Advantages of prices
– Prices are neutral because they do not favor
the buyer or the seller.
• They are the result of competition
• Prices are flexible, allowing for expected
changes in the market
• Prices have no administration costs.
• Prices are familiar and easily understood
The price adjustment process
• Together supply and
demand form a complete
picture of the market.
• The equilibrium price is
the price at which supply
and demand meet
• Surpluses occur when
supply exceeds demand
• Shortages occur when
demand exceeds supply
• Price adjustments help a
competitive market reach
equilibrium
Explaining and Predicting Prices
• A change in price is normally the result of
a change in supply, a change in demand,
or both
• Even small changes in an inelastic supply
can cause big changes in price.
• Elastic supply and demand help keep
prices from changing dramatically
Competitive price theory
• In theory, a
competitive market
allocates resources
efficiently.
• To be competitive,
sellers are forced to
lower prices
• Competition among
buyers keeps prices
from falling too low.
Price ceilings and price floors
Price ceiling
• Law sets price ceiling, or
maximum price that sellers
can charge for a good or a
service.
• Price ceilings often set by
local and federal
governments.
• Excess demand and excess
supply occur when quantity
demanded is greater or less
than quantity supplied
Price floor
• Government sets price
floor, or minimum price
that must be paid for a
good or service
• Minimum wage is the
price floor that an
employer must pay their
workers per hour