 Section
1: Price as Signals
 And
 Section2: The Price System at Work
 More
producers in a market increases
supply which leads to increased
competition and a lower equilibrium price
 Competitive
pricing occurs when
producers sell goods and services at
lower prices to lure customers away from
rival producers while still making a profit
 Elm
Street Hardware prices its snow
shovels at $20
 Uptown Hardware prices its snow
shovels at $13
◦Uptown would then have a lower
profit margin per shovel but ideally it
would sell more shovels at the lower
price of $13
 In
a market economy, the price
system has 4 characteristics:
◦1. It is neutral: the interaction
between producers and consumers
determines the equilibrium price
in the market.
2. It is market
driven: market
forces
determine
price of
goods/services
 3.
It is flexible: when market
conditions change, prices change too.
Surpluses and shortages motivate
producers to changes prices to reach
equilibrium.
 4.
It is efficient:
prices will
adjust until the
maximum
number of
goods and
services are
sold.
 The
laws of demand and supply
show that consumers and producers
have different attitudes toward price
◦Consumers want to buy at low
prices
◦Producers want to sell at high
prices
 The
price system
has 2 great
advantages: it
provides
information and
motivation
◦ Prices provide information by acting as
signals to producers about whether or
not it is a good time to enter/leave a
market
 Rising prices and the expectation of
profits motivate producers to enter a
market
 Falling prices and the possibility of
losses motivate them to leave a
market
A
shortage is a market signal that
consumer demand is not being met
by existing suppliers
◦Producers see that as an
opportunity to raise prices
Higher prices are an incentive for
producers to enter a market
 When
more producers are motivated
by higher prices to enter a market,
quantity supplied increases
 When
prices are too high relative to
consumer demand, a surplus occurs
 Producers
respond to a surplus by
reducing prices or reducing
production
◦Falling prices are a signal that it is
a good time for producers to leave
the market
 While
prices are signals that are
visible in the market, it is the
expectation of profits or the
possibility of losses that motivated
producers to enter or leave a
market
 Prices
also act as signals and incentives
for consumers
 Surpluses that lead to lower prices tell
consumers that it is a good time to
buy a particular good/service
 Producers
send
signals to
consumers in
the form of
advertising and
store displays
 High
prices discourage consumers
from buying a particular product
◦Often high prices are a signal that
it is time for a consumer to switch
to a substitute good with a lower
price
A
high price may signal that a good is
in short supply or has a higher status
◦Think name brand goods
 Definition:
the legal maximum price
that sellers may charge for a
good/service
◦This is a price below the
equilibrium price and results in a
shortage
 Rent
control means that despite what is
going on in the market, rent prices cannot
exceed a certain level
◦ This leads to a shortage of rental
properties
◦ Often these rental properties are not
well-maintained due to the fact that the
rent cannot go above a certain point
 Definition:
legal
minimum
price that
buyers must
pay for a
good/service
 Minimum
wages
are set below the
equilibrium price
to prevent the
wage from
becoming
unprofitable
 The
market uses prices to allocate
goods and services
◦Rationing is an example in which
the government allocates
goods/services using a factor other
than price
 Generally
a rationing system uses
coupons that allow each person only
a certain amount of a specific good
◦The black market, the illegal
buying and/or selling of a good,
can be used to avoid rationing

1. A local supermarket decides to sell a premium
brand of meats and cheeses in its deli department.
This brand is priced $2 more per pound than the store
brand. About 80% of the space in the deli display
cases is devoted to the premium brand and 20% to
the store brand.
◦ A. How did price serve as an incentive to the
supermarket?
◦ B. What kind of signals is the supermarket sending
to its customers with this pricing strategy?
 2.
The percentage of workers who were
paid the minimum wage or less
decreased from 6.5% in 1988 to 3% in
2002 to 2.7% in 2004. What does this
trend tell you about the relationship of
the minimum wage to the equilibrium
wage for those kinds of work?