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The Price System 5.1

The Free Enterprise System primarily relies on the price system to answer the basic economic questions, What, How, and for Whom to produce.

Prices—serve as the main form of communication between producers and consumers in free enterprise.

Benefits of the Price System 5.1

Benefits of the Price System: Information IncentivesChoiceEfficiencyFlexibility

Information

Both Producers and Consumers gather information through the price system. Tells producers how much they must pay to make

their products.Businesses need to know their costsConsumers need to know the price of goodsHow could you shop effectively?

Incentives 5.1

Incentive—Something that encourages you to behave in a certain way.

High prices/Low costs=Encourages producers to supply more goods.(Law of Supply).

Low prices=Encourages consumers to buy more

(Law of Demand).

Note: If there were no price incentives it would make the producers and consumers lives more difficult.

Choice 5.1

The higher the incentive to supply products to the market, the greater the choice of products supplied.

Ex. Athletic clothing market– High demand which drives profits and demand higher.Higher prices encourages competitionCompetitors supply more different productsChoose $300 jogging suit or $20 warm-up

pants

Efficiency 5.1

Price system encourages efficiency in 2 ways:1. Allows for wise use of resourcesHigh demand=Producers allocate resources to

demand.Low demand=Producers will switch to

alternativesLimits waste of raw materials2. Quickly delivers information to producers

and consumers. Prices to high/too low?

Flexibility 5.1

Supply and Demand of goods changes constantly.

Ex. Spiderman II—Quickly produced consumer demand for clothing, toys, styles, etc.

Floods, Hurricanes, Loss of crops, can change prices rapidly.

Hurricane Katrina—Reduction of oil refined

Limitations of Price System 4.1

Market Failures=Market limitationsExternalities—Side effects for people not

directly connected with production or consumption of goods.

Negative externality—when someone who does not produce or consume a good yet bears a part in the cost of production.

Ex. Paper Factory pollution (People living nearby)

Externalities 5.1

Positive Externality—Someone who does not produce or consume a certain product yet benefits from a goods production.Ex. Restaurant near a factory benefits from

locationEx. Neighbors home security systemsRestaurant on Mill Avenue in Tempe

Public Goods 5.1

Public Good—Is any good or service that is consumed by all members of a group.

Ex. National defense, judicial system, law enforcement. Government “forces” people to pay for these

goodsSome would choose not to pay for these

services unless “forced” to.

Instability 5.1

As the price system reacts quickly to events, prices can swing quickly and dramatically between extremes.Ex. Weather, natural disasters, worker

strikes, can cause prices to swing wildly and potentially put companies out of business.

High Gas Prices