Economics » Labour and Financial Markets » The Market System as an Efficient Mechanism for Information

Key Concepts and Summary

Key Concepts and Summary

The market price system provides a highly efficient mechanism for disseminating information about relative scarcities of goods, services, labor, and financial capital. Market participants do not need to know why prices have changed, only that the changes require them to revisit previous decisions they made about supply and demand. Price controls hide information about the true scarcity of products and thereby cause misallocation of resources.

Review Question

1. Whether the product market or the labor market, what happens to the equilibrium price and quantity for each of the four possibilities: increase in demand, decrease in demand, increase in supply, and decrease in supply.

Problems

1. Imagine that to preserve the traditional way of life in small fishing villages, a government decides to impose a price floor that will guarantee all fishermen a certain price for their catch.

  1. Using the demand and supply framework, predict the effects on the price, quantity demanded, and quantity supplied.
  2. With the enactment of this price floor for fish, what are some of the likely unintended consequences in the market?
  3. Suggest some policies other than the price floor to make it possible for small fishing villages to continue.

2. What happens to the price and the quantity bought and sold in the cocoa market if countries producing cocoa experience a drought and a new study is released demonstrating the health benefits of cocoa? Illustrate your answer with a demand and supply graph.

Critical Thinking Questions

1. Why are the factors that shift the demand for a product different from the factors that shift the demand for labor? Why are the factors that shift the supply of a product different from those that shift the supply of labor?

2. During a discussion several years ago on building a pipeline to Alaska to carry natural gas, the U.S. Senate passed a bill stipulating that there should be a guaranteed minimum price for the natural gas that would be carried through the pipeline. The thinking behind the bill was that if private firms had a guaranteed price for their natural gas, they would be more willing to drill for gas and to pay to build the pipeline.

  1. Using the demand and supply framework, predict the effects of this price floor on the price, quantity demanded, and quantity supplied.
  2. With the enactment of this price floor for natural gas, what are some of the likely unintended consequences in the market?
  3. Suggest some policies other than the price floor that the government can pursue if it wishes to encourage drilling for natural gas and for a new pipeline in Alaska.

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