Econ 2 Files
Econ 2 Lecture
Notes
Lecture 5: Markets and Prices
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Economics 2 |
Lecture 5: Markets and Prices
the three basic economic questions
markets and prices
The Three Basic Economic Questions
All economic systems must have some way of answering 3 basic questions:
- What goods and services are produced and in what quantities?
- How are they produced?
- Who gets the goods and services that are produced?
There are two extreme systems for answering these questions. In a command economy, the government decides all the answers. In a market economy, the questions get answered through the interaction of buyers and sellers in the market.
command economy:
- government sets prices
- government ownership of resources
- freely determined prices
- private ownership of resources
Most actual economies contain a mix of private and government decisionmaking. In the United States, consumer demands determine the answer to the first question. Firms are in business to make profits and profits are made by producing the things that consumers want. Consumer sovereignty refers to the ability of consumers through their purchases to determine what goods and services get produced in a market economy.
Goods and services are produced using the combination of inputs that minimizes costs. If firms do not minimize costs, then they cannot maximize profits.
Income determines the amount of goods and services households obtain. Income is determined by the prices of the resources households own. Those with more valuable resources receive a higher income and, consequently, can purchase more goods and services.
Markets and Prices
A market is a place or service that enables buyers and sellers to exchange goods and services. The scope of a market is the area over which a single price prevails. Some markets are worldwide like the gold, oil, and rubber markets. Clothing markets tend to be national in scope. Arbitrage, profiting from different prices for the same product, is what drives prices to be similar among different locations.
Suppose that I can rent a Ryder truck for $100 to take 1 ton of stuff from York to Lancaster. If gold sells for $956.50 an ounce in York and $957.00 an ounce in Lancaster, I would earn profits of $16,000 minus $100 if I bought 1 ton of gold in York, drove it over to Lancaster in the Ryder truck, and sold it. I am engaging in arbitrage: profiting from different prices in different markets for the same good. Arbitrage will drive up the price in York and drive the price of gold in Lancaster down until there were no further arbitrage profits available. The price of gold will be almost exactly the same in the two towns.
As products get heavier and heavier and their value relative to their weight diminishes, shipment to distant points to take advantage of price differences becomes less and less profitable.
Consider bricks: if bricks cost 10 cents a pound in York and 14 cents a pound in Lancaster, I would receive just $80 net income if I bought a ton a bricks here and sold them in Lancaster. This does not even cover the costs of renting the Ryder truck. So, there are no arbitrage profits to be earned from the different brick prices. The brick prices in the two cities would stay different while the price of gold would become close to the same in both cities.
The scope of a market is the area over which a single price prevails. So, the gold market is worldwide, but the brick market is strictly local. Brick producers in Lancaster do not compete with brickyards in York.
A price is the amount paid for a specified quantity and quality of a good or service.
3 functions of price:
- provides incentives
- means of rationing scarce supplies
- signaling mechanism
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David A. Latzko Business and Economics Division Pennsylvania State University, York Campus office: 13 Main Classroom Building phone: (717) 771-4115 fax: (717) 771-4062 e-mail: 
web: www.yk.psu.edu/~dxl31 |
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