PRICES, PRICING
I. Where do Market prices come from?
A. subjective values and actions of the individuals
B. direct goods and services to the persons who value them most
C. “market price” to “clear the market”
D. high prices
E. low prices
F. prices always determined by the choices and preferences of individuals in a free
market
II. The market economy = many auctions
A. Auctions are taking place all the time
1. “on the auction block”
2. advertisements
3. scales of values
B. Market prices emerge from the specific purchases, and/or refusals to purchase
C. Three examples to illustrate
1. Some questions
a. How many trades will result under the assumed conditions?
b. What are the limits within which the market price will fall
2. Problem A: competitive market
a. The process
$2,600—10 potential buyers will clamor to purchase, but only a
single cab will be offered
$2,800—9 eager buyers want to buy, but only 2 cabs will come on
the market
$3,050—8 potential buyers are willing to pay that much, but only 3
cabs will appear on the market
$3,130—7 would-be purchasers are bidding, but only the same 3
cabs are offered by their current owners
$3,250—6 would-be buyers are now in the market, but only 4
owners of cabs are willing to sell—too few to satisfy the demand at
this price
$3,300—6 would-be purchasers are still bidding and a 5th owner is
now ready to sell, but this is still one short of satisfying the market
demand at this price
$3,360-$3,379.99—SOLD!
b. to “clear the market,” the price must be:
1) more than $3,130
2) less than $3,400
c. between $3,360 and $3,380 as follows:
3) $3,360 or more
4) less than $3,380
d. prices up to the margin
e. prices down to the margin
f. between $3,360 and $3,379.99
3. Problem B: a sellers’ market
4. Problem 3: Buyers’ Market
III. Review
A. Basic assumptions
1. Economics: study of the conscious, purposive actions of individuals to relieve
some “felt uneasiness” and thus to accomplish the most urgent goal on his or her
personal scale of subjective values.
a. “ordered universe”
1) Regularity
2) Logic
3) Causality
4) Time
5) Change
6) Value
b. all acting individuals
1) act purposively to attain ends
2) wants are endless
3) means are limited
4) values are personal (subjective)
5) ideas, values and goals are always changing
6) may make mistakes
7) aiming at what most important
8) “economize”
c. Three conditions
1) dissatisfaction, a “felt uneasiness”
2) idea
3) hope
d. There are three requirements for acting.
1) Planning
2) Time
3) Necessary resources (tools, knowledge, etc.)
2. Find easier and better ways
a. to acquire, hold and use private property
b. specializing, cooperating and exchanging
c. economic concepts follow “naturally” and logically
1) Private Property
2) Specialization and Division of Labor
3) Exchange
4) Social Cooperation
5) Markets
3. Economic theory: to explain complex modern market economy
B. Every individual always aims at what he wants most
1. An individual's urgency, or indifference affect “price”
2. Everyone always weighing relative worth
a. what he wants
b. what he has
3. Different list of wants and scale of values
4. more eager buyers
5. more eager sellers
6. market price of any definite quantity of a good or service
a. a particular time and place
b. different viewpoints
c. willing exchange results
C. diamonds vs. water
1. “paradox of value”
2. A particular place and time
3. urgency of the individual's demand under the circumstances
4. scarcity + utility
D. How does an individual decide among many possible alternatives?
1. at any moment
2. “bite-sized” pieces or stages
3. acts only when the satisfaction is better
4. “marginal utility”
5. “marginal unit”
a. “A horse! A horse! My kingdom for a horse!”
WILLIAM SHAKESPEARE, Richard III (ACT V, SCENE IV)
1) What is the marginal unit?
2) What is its marginal utility?
3) What is the value of this marginal unit?
b. “A little Neglect may breed great Mischief: for want of a Nail the Shoe
was lost; for want of a Shoe the Horse was lost; and for want of a Horse
the Rider was lost, being overtaken and slain by the Enemy; all for want of
Care about a Horse-shoe Nail.”
BENJAMIN FRANKLIN, MAXIMS PREFIXED TO Poor
Richards Almanac (1757)
1) What is the marginal unit?
2) What is its marginal utility?
3) What is the value of this marginal unit?
c. submarginal
d. psychic price
IV. How do the ideas and values of countless individuals lead in time to market prices?
A. The economy = uncounted billions of individual value judgments and actions
B. How do the ideas, values, choices and actions of an individual help to determine the
pattern of production?
C. How do the ideas, choices and actions of individuals help to determine market prices?
1. sellers continually experiment to discover the “market price”
2. Charts, graphs and computers offer no help
3. past experience but current situations
V. Equilibrium Price
A. Alfred Marshall:
1. when supply and demand meets in the marketplace, a market price is
created
2. Marshallian Cross
B. Equilibrium price
C. Market clearing or market price
D. No such thing: there is NO equilibrium
E. constant movement +/-: that is competition
Quantity Demanded Price Quantity Supplied
16 $.50 0
12 1.00 4
8 1.50 8
4 2.00 12
0 2.50 16
Supply and Demand Curves
Do not say supply equals demand, merely supply and demand intersects at price x and quantity
Y.
Equilibrium Quantity and Price
What happens if the price is $10?
What happens if the price is $6?
What happens if the price is $8?
Unit 3: Microeconomics Visual 1.9
Shifts in Demand and Supply
National Council on Economic Education http://apeconomics.ncee.net
Unit 3: Microeconomics Visual 2.6
National Council on Economic Education http://apeconomics.ncee.net
Changes in Supply and Demand, and Equilibrium
A. Changing demand with supply held constant:
1. Increase in demand will increase equilibrium price and quantity
2. Decrease in demand will decrease equilibrium price and quantity
B. Changing supply with demand held constant:
1. Increase in supply will decrease equilibrium price and increasing quantity
2. Decrease in supply will increase equilibrium price and decreasing quantity
C. Complex cases—when both supply and demand shift:
1. If supply increases and demand decreases, price declines
2. If supply decreases and demand increases, price rises
3. If supply and demand change in the same direction, quantity will be in the
direction of the shift
D. A Reminder: Other things equal:
1. Demand: inverse
2. Supply: direct relationship
3. Be careful of time
4. Many factors other than price
Elasticity describes the responsiveness to price changes
5 types
Categories of Elasticity
1. Perfectly Elastic
2. Elastic
3. Unitary Elastic
4. Inelastic
5. Perfectly Inelastic
Qualities That Affect Elasticity of
Demand
Unit 3: Microeconomics Visual 2.7
National Council on Economic Education http://apeconomics.ncee.net
Elasticity and Total Revenue
The total receipts test for demand
Estimating Elasticity of Demand
ECONOMIC PRODUCTS
Determinants Tomatoes T-bone Table Gasoline Gasoline Services Insulin Butter
Elasticity steak salt form a in of
Particular General Medical
station Doctor
Can purchase Yes Yes No Yes No No No Yes
be delayed?
Yes (elastic)
No (inelastic)
Are there Yes Yes No Yes No No No Yes
adequate
substitutes?
Yes (elastic)
No (inelastic)
No
Does purchase use a No No Yes Yes Yes No No
large portion
of income?
Yes (elastic)
No (inelastic)
Type of Elastic Elastic Inelastic Elastic Inelastic Inelastic Inelastic Elastic
Elasticity
Characteristics that Affect Elasticity
A) Nature of the product
B) Durability of the product
C) Size of the expenditure
D) Substitute goods
E) Complementary goods
F) Time
Characteristics of Elastic and Inelastic Goods.
Elastic Inelastic
durable non-durable
expensive inexpensive
luxuries necessities
substitute goods complementary goods
The Midpoint Formula
Price per candy bar Q demanded per week Total Revenue Elasticity Coefficient
.40 3 $1.20
.35 4 $1.40
.30 5 $1.50
.25 6 $1.50
.20 7 $1.40
.15 8 $1.20
Mid point formula
The elasticity ( ) formula used is:
= ( Q / Q0) / ( P / P0)
where Q = Q1 -Q0
and P = P1 - P0
Note: The mid-point formula will provide more accurate results for cases when the
sign of marginal revenue changes along the segment in question. The mid-point
formula is:
= ( Q / [(Q0+Q1)/2]) / ( P / [(P0+P1)/2])
where Q0 = initial or old quantity
Q1 = final or new quantity
P0 = initial or old price
P1 = final or new price
Price elasticity of demand Demand curve is Rise in the price will Fall in the price will
>1 elastic decrease the revenue increase the revenue
=1 unitary elastic not change the revenue not change the revenue
1 crosses x above (0,0)
i) inelastic e<1 cross y before (0,0)
Effects of Different Demand Elasticities
Which demand curve is more inelastic?
What happens to the equilibrium price and quantity
with an elastic demand curve if supply increases?
What happens to the equilibrium price and quantity
with an inelastic demand curve if supply increases?
Unit 3: Microeconomics Visual 1.12
National Council on Economic Education http://apeconomics.ncee.net
Price Ceilings and Floors
Price Floor
Problems: surplus, inefficiencies, wasted resources, encourage illegal activity
Case Study: Agricultural Price Support
destroying the crops or bribing the farmers not to produce, higher taxes
Price Ceilings
There are four alternatives to the market as a way of allocating a scarce good:
standing in line
preferred customers
coupon rationing
black markets
Case Study: Lines at the Gas Pump
In 1973, OPEC raised the price of crude oil which led to a reduction in the supply of gasoline.
The federal government put price ceilings into place which further increased shortages.
Motorists were then forced to spend large amounts of time in line at the gas pump (which is how
the gas was rationed.) These people waiting in line could have been doing something more
enjoyable or productive.
RECOMMENDED READINGS
JA Chapter 5
Chapter 6 Economic Reasoning
Chapter 7 Economic Reasoning
Graying of America, EPI
Smog Merchants, EPI
Greenhouse Economics, EPI
Heavenly Highway, EPI
If Men were Free to Trade, John C. Sparks
For the Good of the Others, Leonard E. Read
Food from Thought, Charles W. Williams
Movies: The River