Foundation for Teaching Economics

Markets

Key Terms

Exchange
Money prices
Transaction costs
Specialization
Property rights
Market-clearing price
Interdependence
Monetary costs
Non-monetary costs

National Content Standards Addressed:

Standard 4 - People respond predictably to positive and negative incentives.

Standard 5 - Voluntary exchange occurs only when all participating parties expect to gain. This is true for trade among individuals or organizations within a nation and usually among individuals or organizations in different nations.

Standard 7 - Markets exist when buyers and sellers interact. This interaction determines market prices and thereby allocates scarce goods and services.

Standard 8 - Prices send signals and provide incentives to buyers and sellers. When supply or demand changes, market prices adjust, affecting incentives.

Standard 9 - Competition among sellers lowers costs and prices and encourages producers to produce more of what consumers are willing and able to buy. Competition among buyers increases prices and allocates goods and services to those people who are willing and able to pay the most for them.

Lesson Objectives (9)

Review the nature of voluntary exchange, drawing on the experiences in "Why People Trade."
- No one forced people to trade; why did they? (anticipation of benefit)
- Who benefited from each exchange? (mutual benefit)
- Why were some people able to trade more than others?
- What was the opportunity cost of the trade you made?
- Were there costs other than the item you gave up in the trade? (search and transaction costs, lost opportunity to trade with someone else etc.)
Define market - and discuss why they are our preferred method of rationing. (Relate to "Why People Trade" - was that a market? how so?)
- How do people behave in markets?
- Markets work as positive sum games when:
  - there are clearly defined "rules of the game;"
  - property rights are clearly established and are protected; and
  - there is freedom to exchange.
- How would our market have been different if we had used money?
Define incentives as both rewards and penalties for behavior.
- There are monetary and non-monetary incentives.
The role of prices in markets.
- Prices provide information.
- Prices act as a rationing mechanism.
- Prices are incentives - for buyers and sellers.
Prices play a crucial coordinating role in commercial societies; they provide incentives for buyers and sellers to act in ways that lessen the impact of scarcity.
- Reminder of law of demand from first lecture: . How do buyers react to changing prices?
- Reminder of law of supply from first lecture: How do sellers react to changing prices?
Define and develop examples of market clearing price.
- Market clearing prices are evidence of the cooperative nature of commercial societies; they help to balance the amount people want to buy with the amount others want to sell.
Clearly defined property rights and prices that move freely in response to changing conditions of demand and supply encourage exchange and the creation of wealth.
- When prices are prevented (whether by custom, ignorance, or government action, for example) from changing in response to changes in demand or supply:
  - the opportunity cost of exchange rises;
  - fewer exchanges take place; and
  - cooperation becomes less likely and less effective.
- While price controls may prevent rising prices, they cannot prevent rising costs; non-monetary costs (search and transaction costs) will rise instead.
- Non-monetary costs are usually deadweight costs: costs to demanders, such as waiting in line, that do not benefit suppliers.
- Reducing the costs of arranging voluntary exchange (transaction costs) increases wealth; increasing transaction costs inhibits the creation of wealth.
Markets and prices encourage specialization and interdependence.
- Refer to "Why People Trade" activity: Why do people trade for things they want rather than producing everything themselves?
- In a society characterized by extensive specialization, people obtain most of what they want by supplying things that satisfy the wants of other people.
Markets are the result of interaction between supply and demand.
- Monetary prices are incentives for buyers and sellers to act cooperatively.
- This cooperation is impersonal and is based on people making choices that reflect their perceptions of opportunity costs.
- This cooperation results in clearing markets of both supply and demand.

Teaching and Discussion Ideas

Sample Small Group Discussion Problems

Pose a problem for small groups, teacher-led discussions that requires students to consider the advantages and disadvantages of different systems of rationing:

War has broken out in the Middle East, sharply reducing the supply of oil to the United States. The government has decided to order a 20% reduction in the production of gasoline for motor vehicle consumption in order to save petroleum. Average annual U.S. consumption of gasoline for motor vehicles before the outbreak of war was 120 billion gallons. It must now be reduced to 96 billion gallons. You are responsible for designing a system to allocate the reduced supply of gasoline. How will you do it?

Pose problems requiring students to recognize that time and transaction costs are taken into account in purchasing decisions.

What is the difference in the cost of buying a coke with no ice from the machine in the mall entryway and buying one with ice from the vendor at the other end of the mall (¼ mile away) if the price of both cokes is 75¢?

Pose a problem that allows students to discover the ability of money and pricing signals to accommodate to particular situations of supply and demand.

Suppose that a series of hurricanes devastates the Bahamas. Most buildings are destroyed; there are many deaths; and all production is disrupted. Predict what would happen if, instead of sending old clothes and foreign aid packages, the United States set up many distribution points and handed out $50/day to any Bahamian, of any age, who showed proof of residency?

Pose a problem that allows students to predict the impact of price controls.

Suppose that a summer of flooding in the Midwest is followed by a summer of severe drought. Two successive failures of the wheat crop mean that bread production is severely reduced.

Predict what would happen if the government, with the well-being of the poor in mind, prevents the price of bread from rising.

Predict what would happen, in both the short-run and the long-run, if the government allows the price of bread to rise.

Definitions

Exchange - Trade; voluntary agreements between buyers and sellers.

Market clearing price - The price at which all that suppliers are willing to sell equals all that buyers are willing to purchase; the price at which quantity demanded equals quantity supplied.

Non-monetary costs - See transaction costs.

Property rights - The conditions of ownership, including the rights and restrictions regarding use, ownership, and sale.

Specialization - Occurs when individuals, businesses, regions or nations concentrate on producing only those goods and services that they can best (most efficiently) produce, given their existing resources.

Transaction costs - The resources (like time and energy) that are used in making an exchange. Examples of transaction costs are time spent shopping or the time and energy necessary to negotiate a contract.

Lesson 2: Markets