Montana Council
on
Economic Education
Randy Rucker
Professor
June 19, 2013
PRICES:
•
•
•
•
•
What Are They?
Which Prices Matter?
What Role Does Currency Play?
What Roles Do Prices Play?
How Are Prices Determined?
PRICES
• What Is a Price?
• A price is the amount paid by a buyer
to purchase a good or service.
• Alternatively, a price is the amount
received by a seller for a good or
service.
• What units?
PRICES
• Examples:
-
Navel oranges: 69 cents per pound.
Avocados: $1.19 each.
Green onions: 79 cents per bunch
Bread: $1.99 per loaf.
Milk: $3.29 for a gallon.
Dreyers Spumoni ice cream: 2 containers (1.5
quarts each) for $6
What happens if you just buy one?
PRICES
• Note that all of these prices are
expressed on a per unit basis—
although the units are not all the same
(pounds, by the each, gallons, loaves,
etc.).
and
• The transactions are relatively
simple—you give the clerk your money
and then you leave with the apples,
bread, or ice cream.
PRICES
• Sometimes, however, the transaction is not quite so simple. For
example,
Awhile back, a new Toyota Rav 4 cost $24,081 at Ressler
If you paid cash.
If you paid $10,000 up front and then borrowed the
balance from the bank on a six year loan at 4.9%, your
monthly payments would have been $226.
If you signed a three year lease and paid $10,000 up
front, you only had to pay $67 per month. But then you
didn’t get to keep it at the end of three years unless you
paid an additional $15,345.
• How much would you have paid for the car?
PRICES
• Suppose I own a furniture store and am trying to
hire a salesperson.
• What price do I pay?
- Maybe hourly ($20 per hour)
- Maybe commission (7% of sales value)
- Maybe a straight salary ($3,200 per month)
- Maybe a salary with a bonus
- Maybe hourly/commission combination
• How much do I pay for this worker?
PRICES
• Which Prices Matter?
-
-
-
Suppose you wake up one morning in a strange land.
You feel something in your pocket and upon reaching
into it, you find a bunch of funny-looking coins with
numbers on them.
You start walking and come to a food stand with a sign
indicating:
- Hot Dogs: *2
- Mountain Dew: *1
- Slice of Meat Lover’s Pizza: *3
You ask the owner of the stand about the coins in your
pocket and he tells you that the numbers on them
correspond to the prices (in terms of asterisks) on his
sign.
PRICES
• What have you learned?
• You now know that you have enough coins in
your pocket to feed yourself.
• You also know that,
- 1 Hot Dog costs you 2 Mountain Dews, or 2/3
of a slice of Pizza
- 1 slice of Pizza costs you 3 Mountain Dews or
1.5 Hot Dogs
- 1 Mountain Dew costs you ½ of a Hot Dog or
1/3 of a slice of Pizza
PRICES
• Prices thought of in this way help you
to understand the trade-offs that you
are able to make between the goods
available at the food stand.
• Next, you might want to walk to
another food stand and see how
competitive the first stand is, and
also whether the available trade-offs
are the same.
PRICES
• Day 2: You wake up and are still in the
strange world. You get up and walk to
the first food stand and see that the sign
has changed to the following:
- Hot Dogs: *4
- Mountain Dew: *2
- Meat Lover’s Pizza: *6
• You are a dismayed to see that all the
prices have doubled.
• But then, you reach into your pocket and
count your coins and realize that you
have exactly twice as many as you had
yesterday.
PRICES
• Are you better or worse off?
- 1 Hot Dog still costs you 2
Mountain Dews
- 1 Slice of Pizza still costs you 1.5
Hot Dogs
- etc.
and
- You can afford to purchase exactly
the same amounts as yesterday.
Thus, you are relieved to realize you are
exactly as well off today as yesterday.
PRICES
• Day 3: You wake up, count your coins (same
as Day 1), walk to the food stand and see that
Hot Dogs now cost *8 (Mountain Dew and
Pizza prices are the same as Day 1).
• Are you better or worse off?
• Price of Hot Dogs has increased relative to
other goods and also relative to your
“income.”
• Thus, you eat fewer Hot Dogs and are worse
off.
PRICES
• So, what prices matter?
Relative prices matter!!
PRICES
What is the Role of Currency?
• Note that currency comes in lots of forms:
- Dollars, Euros, Funny looking * Coins,
Bitcoins, Cigarettes, Seashells, etc.
• Currencies reduce the costs of exchange.
• Imagine a grocery store with no currencybased prices . . .
PRICES
• A sign might be posted by each item offered
- Package of pork chops will be exchanged for:
12 pounds of potatoes
Two 1.5 quart containers of Dreyer’s
Spumoni ice cream (frozen)
Three 16 oz. boxes of Raisin Bran
Cereal
One 12-pack of Diet Pepsi (or 9
MGD’s)
-
To get the pork chops, you have to provide
the store owner with one of these.
-
How costly would that be?
PRICES
• What Roles Do They Play?
1. They provide information about relative
values (e.g., 1 Hot Dog costs 2 Mtn Dews).
2. Prices denominated in currency reduce the
costs of transactions.
PRICES
• What Roles Do They Play? (continued)
3. They provide signals (and incentives) to
producers and consumers.
- Suppose the price of corn increases (i.e., corn
becomes more scarce)
Producers have the incentive to
produce more.
Buyers have the incentive to consume
less. Consumers and feedlot owners
switch to substitutes.
PRICES
• What Roles Do They Play? (continued)
4. They act as a rationing device.
Suppose the government decides
that you own all the water in the
state.
Way more water than you can use, so
you decide to re-distribute most of
the water to others.
PRICES
• How will you ration the water among
competing users?
– You could give it to your friends. How many
friends will you have?
– First come-first served. How long with the lines
be?
– Establish a price and lease or sell it to those who
place the highest value on the water. How to set
the price?
PRICES
• How Are Prices Determined?
- In a free market, prices will be determined
by the interaction between supply and
demand. Price ($/Q)
S0
P0
D0
Q0
Quantity
The Market for Hot Dogs
PRICES
• Sometimes, however, authorities intervene and override the market process.
- For example,
- Price Supports & Price Ceilings
- Production Quotas
- Taxes & Subsidies
- And so forth . . .
Such policies prevent the price system from working and
compromise the information conveyed by prices.
Each of these, however, is a story for another day . . .
PRICES
Overview of our discussion:
•
What Are Prices?
•
Which Prices Matter?
•
What Role Does Currency Play?
•
What Roles Do Prices Play?
•
How Are Prices Determined?
PRICES
• QUESTIONS?
PRICES
• Sometimes, however, authorities intervene
and over-ride the market process.
- For example,
- Price supports (price can’t fall below PS)
Price ($/Q)
Surplus
S0
PS
P0
D0
Q0
Quantity
The Market for Hot Dogs
With a Price Support
PRICES
• Price ceilings (price can’t rise above PC)
Price ($/Q)
S0
P0
PC
Shortage
Q0
The Market for Hot Dogs
with a Price Ceiling
D0
Quantity (Q)
PRICES
For example (continued):
• Production Quotas
• Subsidies
• Taxes
• And so forth . . .
Such policies prevent the price system from working
and compromise the information conveyed by free
market prices.
Each of these, however, is a story for another day . . .