What Role Do Prices Play?
Prices Convey Information to
Consumers and Producers
“Prices are like messengers conveying news”
~Thomas Sowell
Prices Convey Information to
Consumers and Producers
• Consumers- price signals the opportunity cost
of a purchase
– The next best use for the money you spend
– When the opportunity cost of buying is high
people tend to think carefully before spending
– Most consumers narrow searches by price range
– Reflects consumer’s expectation of what will be
available at that price
Prices Convey Information to
Consumers and Producers
• Producers- price tells them what consumers
want
– A way to gauge consumer preferences
– Appeal to consumers they hope will buy their
products
– Use price to send a message about products and
their intended markets
Prices Create Incentives to
Work and Produce
• Incentives-matter principle
• Price as incentive because of potential for
profit
• Rising prices motivate production increase
• Falling prices motivate decrease of production
• Prices in the form of wages motivate workers
– High wages inspire job-seeking
– Low wages act as disincentive for people to seek
work
Think/Pair/Share
• Think: When home prices increase or
decrease, what industries/people are affected
or inspired to action?
• Pair: With a partner compare and combine
your lists of industries/people; then discuss
how might they react to a home price increase
and a decrease?
• Share: Be prepared to share at least one
example with the class
Prices Allow Markets to Respond to
Changing Conditions
• Prices give markets the flexibility the need to
reach equilibrium even under changing
conditions
– Hurricanes Katrina/Rita 2005
• By throwing gasoline market into disequilibrium,
illustrated the key role that prices play in correcting
both shortages and surpluses
Prices Allocate Scarce Resources
Efficiently
• Guide resources to their most efficient uses.
– Ex. Dairy products
• Yogurt, ice cream, cheese
• Greatest demand will buy the most milk in order to
make products to meet that demand
• Producers automatically allocate milk (scarce resource
used to make many different products) to its most
valued use
Prices in General
• When prices are allowed to freely rise and fall
to their equilibrium levels, they do an effective
job of allocating scarce resources to their best
uses.
How Government Intervention
Affect Markets
How Government Intervention
Affect Markets
The record of price controls goes as far back as
human history. They were imposed by the
Pharaohs of ancient Egypt. They were decreed
by Hammurabi, king of Babylon, in the
eighteenth century B.C. They were tried in
ancient Athens.
—Henry Hazlitt, 1993
Why Governments Intervene in
Markets
• Occasionally governments intervene in the
market in an attempt to influence prices
• They do this by placing limits on how high or
low certain prices may be. (price controls)
Why Governments Intervene in
Markets
• When persuaded that supply and demand will
result in prices that are unfairly high for
consumers or unfairly low for producers.
– 1970s price controls on gas in response to
reduced shipments of foreign oil b/c of crises in
Middle East
• Set price floors or price ceilings, both affect
supply & demand
Price Floors Lead to Excess Supply
• Price Floor: Minimum price consumers are
required to pay for a good or service
– Meant to push prices up, ensures benefit for
producers
– Minimum wage: Government-imposed legal floor
on the hourly wage rate
• Rationale: in low-skill job markets, supply and demand
would drive the equilibrium wage so low that many
workers would earn to little to live decently
– Result: Excess supply
Price Ceilings Lead to Excess Demand
• Price Ceiling: maximum price consumers may
be required to pay for a good or service.
– Meant to enable consumers to buy essential
goods or services they wouldn’t be able to afford
at the equilibrium price
– Often established in response to crises
– Rent Control: make it illegal to charge more than a
specified monthly amount for rental housing.
Introduced in WWII to protect poor families
Dealing with Excess Supply and Demand
• Price controls prevent market clearing price
resulting in excess supply or demand
• Shortages  rationing: controlled distribution
of a limited supply or a good or service
– License plate number gas purchases
– WWII tires, gas, sugar and other goods
• Shortages black market: an illegal market in
which goods are traded at prices or in
quantities higher than those set by law.
Think/Pair/Share
• Think: What are some examples of a price
ceiling leading to excess demand, or a price
floor leading to excess supply?
• Pair: With your partner develop one example
into a brief story.
• Share: Be prepared to share your example or
story with the class.