Teaching Students How Markets Work — Market Changes, Price Determination and Elasticity

Lesson Purpose:

In this lesson, we build on the basic components of the market model to explain the complexities of the markets we participate in everyday. For example, understanding price elasticity helps us to explain why consumers respond differently to similar price changes in markets for different products, and why sellers have different marketing strategies for different products. Understanding the conditions necessary for price discrimination lets us explain why the family in the seats across the aisle paid less for their plane tickets than we did.  And finally, there is the perennial question of whether government should place limits on how much may be charged or how little can be paid for products. Being able to analyze the impact of price controls – price floors and price ceilings – empowers students to answer that question thoughtfully and on their own.

Key Terms:

price elasticity of demand price elasticity of supply

price control price floor price ceiling

price discrimination

Content Standards:

Standard 8: Students will understand that: Prices send signals and provide incentives to buyers and sellers.  When supply or demand changes, market prices adjust, affecting incentives.
Benchmarks:
grade 12:

• Demand for a product changes when there is a change in consumers’ incomes or preferences, or in the prices of related goods or services, or in the number of consumers in a market.
• Supply of a product changes when there are changes in the prices of the productive resources used to make the good or service, the technology used to make the good or service, the profit opportunities available to producers by selling other goods or services, or the number of sellers in a market.
• Government-enforced price ceilings set below the market clearing price and government-enforced price floors set above the market clearing price distort price signals and incentives to producers and consumers.  The price ceilings cause persistent shortages, while the price floors cause persistent surpluses.

Session Objectives:

• Introduce the concept of ‘market distortions’ via price ceilings and price floors.
• Demonstrate the effects (surplus and shortage) of price controls on the market.
• Discuss the difference between intention and results in enacting price controls – emphasize incentive responses of consumers and producers.
• Explain how price controls distort resource allocation.
• Introduce the concept of elasticity and explain why an understanding of elasticity is important to consumers, businesses, and governments.
• Identify the factors affecting elasticity: number and availability of substitutes, percentage of total income, length of time.
• Demonstrate ways to determine relative elasticity of demand and how it is useful knowledge for producers.
• Define price discrimination.
• Identify the conditions necessary for price discrimination: ability to identify, at low cost, consumer groups with different elasticities; ability to prevent resale.
• Practice analysis of scenarios/problems with price controls, elasticity, and price discrimination.  Discuss/share answers.  Provide feedback.

Key Content:

• Price controls – price floors and price ceilings – prevent markets from adjusting to changing conditions of relative scarcity.
• Price controls create persistent shortages and surpluses.
• Price elasticity is a measure of the responsiveness of demand (or supply) to changes in price.
• Price discrimination – the practice of charging different consumers different prices for the same product – recognizes that opportunity costs vary among individuals.
• Price discrimination is possible when different consumer groups have different elasticities of demand, when those groups can be identified at low cost, and when product resale can be prevented or is highly unlikely.

Mythconceptions:

• When the price of an item increases, consumers will always buy less.
• Price ceilings and price floors help an economy run efficiently.
• Price controls help poor people and those suffering in disasters.
• It’s not fair when people pay different prices for the same thing.
• Producers and sellers lower prices to put their competitors out of business, not to increase profits.

Frequently Asked Questions:

• Is it always in the best interest of a business to raise the price of its product(s)?
• Why will some people continue to buy a product as its price continues to rise?
• Why do people pay different prices for the same product?
• Why does business want to know the price elasticity of demand for an item?
• Why would government want to know about price elasticity of demand for an item?
• How does the market ‘eliminate’ surpluses and shortages?
• Who is helped by price ceilings and price floors? Who is hurt by them?
• How do price ceilings and price floors ‘distort’ the market?
• Why do people pay different prices for the same product?

Classroom Activity Options

• Provide examples – both graphic and narrative – of products with differing elasticities of demand and supply.
• Provide an exercise in which students use the characteristics of elasticity (availability of substitutes, percent of income or size of expenditure, length of time) to order products in terms of their relative elasticities for different consumers.
• Show examples of the general characteristics of more elastic and less elastic demand and supply curves.
• Optional – for advanced students: Explain elasticity equations and graphs, and provide practice problems.
• Provide practice problems – both graphic and narrative – in which students predict or explain the market impacts of price controls.
• Bring in and discuss with students examples of price control controversies or proposed policies/legislation from the news.
• Provide practice scenarios of price discrimination (movie theater tickets, grocery coupons, airline tickets – or have students generate their own) and have students explain how the sellers identify different consumer groups.

Handouts and Supplemental Materials

• Practice problems