<Standard E.2.2 .................................................................................................................................................................................. Standard E.2.4>

Describe how prices send signals to buyers and sellers.


Gas Prices, Lewiston, Maine, 2008
Gas Prices, Lewiston, Maine, 2008

Focus Question: How do prices impact buyers and sellers?


Topics on the Page
Price Signals
Supply and Demand
Reservation Prices
Price Fixing
Free Price vs. Fixed Price


Price Signals

podcast icon.pngThis podcast from 'econlowdown' describes the essentials on 'Price Signals'



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Watch this video for an overview of market efficiency and price signals from Crash Course.

Supply and Demand


For more information on supply and demand visit Economics standard 2.1

The market price of a good is determined by both the supply and demand for it.
  • In 1890, English economist Alfred Marshall published his work, which was one of the earlier writings on how both supply and demand interacted to determine price.
    • Click here to explore Marshall's Principles of Economics from the Library of Economics and Liberty.
  • Today, the supply-demand model is one of the fundamental concepts of economics. The price level of a good is determined by the point at which the quantity supplied equals the quantity demanded.
  • To illustrate it, consider the following case in which the supply and demand curves are plotted on the same graph.
Alfred_Marshall_-_Principles_of_Economics_(1890)[1].JPG

external image supplydemand.gifSupply and Demand


On the example above, there is only one price level at which quantity demanded is in balance with the quantity supplied, and that price is the point at which the supply and demand curves cross which is known as the equilibrium point.

The law of supply and demand predicts that the price level will move toward the point that equalizes quantities supplied and demanded. To understand why this must be the equilibrium point, consider the situation in which the price is higher than the price at which the curves cross. In such a case, the quantity supplied would be greater than the quantity demanded and there would be a surplus of the good on the market.

external image supplydemandshift.gifShift in Demand


In the graph above, the positive shift in demand results in a new supply-demand equilibrium point that in higher in both quantity and price. For each possible shift in the supply or demand curve, a similar graph can be constructed showing the effect on equilibrium price and quantity. The following table summarizes the results that would occur from shifts in supply, demand, and combinations of the two.

Result of Shifts in Supply and Demand

Demand
Supply
Equilibrium
Price
Equilibrium
Quantity
+

+
+
-

-
-

+
-
+

-
+
-
+
+
?
+
-
-
?
-
+
-
+
?
-
+
-
?
  • In the above table, "+" represents an increase, "-" represents a decrease, a blank represents no change, and a question mark indicates that the net change cannot be determined without knowing the magnitude of the shift in supply and demand.
  • These shifts in market equilibrium can have a ripple effect on economic markets. These shifts create externalities (unintended consequences that effect the general population).
    • Click here to read about the externalities that are produced by a drop in oil prices.
      Climate change as an externality of carbon emissions.
      Climate change as an externality of carbon emissions.

For a different perspective, see Using Maths to Find Equilibrium Price and Quantity

This is information from a Supply and Demand Lecture

Click here for an example of how economists use price signals as economic indicators.

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Click here for more information on supply and demand, and the concept of market equilibrium from Khan Academy.


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Click here for a lesson plan using toy fads to explain supply and demand from EconEdLink.



Reservation Prices


Here is a PowerPoint presentation from the University of California Santa Barbara.

For information on reservation prices for buyers and sellers, see Tutorial 2: Reservation Prices from a course at Illinois State University.

This is a glossary definition of Reservation Prices and short video explaining the word.

Price Fixing

The Bosses of the Senate, 1889
The Bosses of the Senate, 1889

Price Fixing defined by the Federal Trade Commission

Identifying Sherman Act Violations from the Offices of United States Attorneys

primary_sources.PNGSherman Anti-Trust Act (1890)
  • The image to the right is a famous political cartoon by Joseph Keppler that contributed to the passage of the Sherman Anti-Trust Act


Free Price system vs. Fixed Price System

womens history.jpgThis article from the New York Times describes the relationship between family structures, gender, and class in regards to price signals

  • Click here for an article on the relationship between price signals and the pay gap between men and women.

lesson_plan_icon.jpgLesson Plan from PBSTeachers: US Agricultural Subsidies and Nutrition: "This lesson plan utilizes the film and POV’s website resources for Food, Inc. , a documentary that examines food in the United States and the industry that produces it. Classrooms can use these materials to investigate how agricultural subsidies influence food choices, health and the economy." Addresses the concept of prices and interaction of supply and demand in a market economy as well as the role of the government, producers and consumers


Sources:
http://www.netmba.com/econ/micro/supply-demand/