CHAPTER 10: Highly integrated constantly changing economic choices need to be coordinated.  Enter first MONEY and then THE PRICE SYSTEM.  

Money is anything that is generally accepted as a medium of exchange.  Tobaccco leaves, beads, stone monuments, cigarettes, and other items have been used.  People finally discovered the benefits of using gold as money and pretty much stuck with it. 

First there were bags of gold.  Next came gold coins.  Then paper money backed by gold.  Then paper money NOT backed by gold (major change). Then demand deposits.  And most recently electronic fund transfers. 

Prices are determined by supply and demand.  More demand leads to higher prices and more supply leads to lower prices.  If you know the price of any two items you can calculate the opportunity cost of your choices.  For example if product A costs 5 dollars and product B costs 10 dollars then the opportunity cost of 1B is 2As.

But why would product A cost you 1/2 as much as product B.  That's where competition comes into play.  Sellers want the highest price they can get but they know that other sellers will get your business if they charge too much.  On the other hand buyers want the lowest price they can pay but they know that other customers might pay more if they offer too little.  This interplay of forces results in high prices for items when there are relatively more buyers and low prices when there are relatively more sellers.

There's a little more to it than this but you get the general idea.

When demand increases, ceteris paribus, prices rise.  This signals sellers to produce more even if the product costs more to produce.  And vice versa.  When supply decreases, ceteris paribus, prices rise.  This has the effect of rationing some buyers out of the market.  And vice versa. 

Thus prices serve as information so that sellers know when to produce more or less and buyers know when to buy more or less.  All without having a price czar to coordiante these decisions.

Another function of prices is to eliminate wasteful surpluses and shortages.  If there is too much being offerred for sale in relation to the number of buyers, prices fall.  If there is too little being offerred in relation to the number of buyers, prices rise.  And this of course takes place without having an allocation czar.

Think of the price system as the eyes of the drivers who must constantly receive information from their surroundings in order to navigate from Point A to Point B.  

Bastiat once asked this famous question:  How does Paris get fed?   No food czar?  No central plan?  No bureaucrats and agencies to tell people what to produce, how to produce it, and who will get it. 

Review Questions:  If a surplus exists will that cause competition between buyers or sellers.  Will this result in the price going up or down.  How about the same question with a shortage?  Can you think of several examples of government price control?  Does government regulation of prices and production interfere with spontaneous order and therefore create inefficiency and disorder?  If the answer is yes, then why do it?