- Introduction to Economics
- The Four Types of Economies
- Opportunity Cost
- Introduction to Demand
- Elasticity of Demand
- Competition (or Lack of It)
- The Economic Structure of The United States
- Business Cycles 1: Four Stages of the Business Cycle
- Business Cycles 2: Inflation, Deflation and Poverty
- The Role of the Government in the Economy
GED Social Studies Practice Test: Prices
J.P. Morgan, the most famous financier of the Gilded Age, was once asked about the cost of having a yacht built. He replied, “If you have to ask, you can’t afford it.” But most of us live in a different universe in which we are sensitive to price — the amount of money a supplier charges for a good or service. A price reflects the cost of production plus the profit. Just because you pay $100 for a dress doesn’t mean it cost the manufacturer $100 to make it. That’s no way to stay in business. If we were to dig deeper (if that were possible), we’d find that it cost the dress manufacturer $80 to make the dress (that takes into account the cost of the fabric, the wages of the workers, and the cost of running the factory), and then tacks on $20. The $20 is the profit.
Prices are not set in stone. No sane businessperson would say, “This is the price of my good or service. Take it or leave it; I don’t care.” There must be a point at which the buyer and seller meet. When consumers pay the price that is asked by a producer, the buyer is happy (or at least happy enough to pay the price) and the producer will have an incentive to continue producing at the current level.
Of course, a business might want to make more profit, and so it will raise prices. But if no one buys at the higher price and business falls off, the business has two options: maintain that the new price is fair and just (and thus set the course for going out of existence), or dropping the price to a point that consumers are willing to pay.
What determines prices? Well, naturally, consumers want to pay as little as possible, and producers want to charge as much as possible. But in the real world, there must be, so to speak, a meeting of the minds. We call this market equilibrium: when the quantity supplied and the quantity demanded are equal. The system of supply and demand has triumphed.
Look at the chart below. The price could be for any good. The quantity is the demand of consumers. Surely the producer would like to sell his/her goods for as much money as possible, and the consumer would like to pay as little as possible. Where the supply and demand curves meet is the equilibrium point. In this case, the market equilibrium is 125,000 units at $75 each.
A surplus occurs when the quantity that is supplied is larger than the quantity demanded. At Point A, the producer has decided to charge $140 per unit and is willing to produce 240,000 units at this price (Point B). This, however, is far beyond the quantity demanded at this price. If you go straight across to Point A, you’ll find that at $140, consumers are only willing to purchase 25,000 units. The result would be a surplus of 215,000 units (240,000 – 25,000 = 215,000). That’s 215,000 units gathering dust in the producer’s warehouse. Not good for the producer. To put it simply, the producer is charging too much. By lowering prices, the producer will sell more units and make more money.
Now let’s look at a shortage, when the demand outstrips supply. Look at Point C. The manufacturer has decided to produce each unit for $13, and is willing to make 25,000 units at that price. But with such a low price, consumers want 240,000 units. The shortage is 215,000 units (240,000 – 25,000 = 215,000). That means the producer could make, and sell, much more.