The Price System: Signals, Speculation, and Prediction

These flashcards cover key concepts from Chapter 7 of the Modern Principles of Economics, focusing on the price system, economic signals, speculation, and prediction markets.

What is the Great Economic Problem?

To arrange our scarce resources to satisfy as many of our wants as possible.

How do prices function in economic markets?

Prices integrate markets, convey information, and create incentives to respond in socially useful ways.

What is the role of entrepreneurs in markets?

Entrepreneurs look for ways to lower costs and respond to price signals, linking seemingly distant markets.

What happens when the supply of oil decreases?

We should economize on oil by shifting it away from low-valued uses to high-valued uses.

What is central planning's limitation compared to the price system?

Central planning often faces problems of information and incentives that the price system overcomes.

What does a buyer compare when deciding to purchase a good?

A buyer compares the value of the good to its opportunity cost, which is reflected in the market price.

What did Friedrich Hayek say about prices during scarcity?

Prices help allocate resources more efficiently without any orders or central coordination.

What does it mean for prices to be signals, incentives, and predictions?

Rising prices signal buyers to use less and suppliers to produce more, guiding economic behavior.

How do losses function in a competitive market?

Losses signal to entrepreneurs that they need to improve or risk going bankrupt.

What is arbitrage?

Arbitrage is buying an item at a low price and reselling it at a higher price.

What is speculation in economics?

The attempt to profit from future price changes.

How does speculation influence prices over time?

Speculation can raise prices today while lowering them in the future, smoothing price fluctuations.

What are futures contracts?

Standardized contracts to buy or sell specified quantities of a commodity or financial instrument at a set price for future delivery.

How do futures markets help reduce risk?

Futures markets allow businesses to lock in prices for goods or services, mitigating exposure to price volatility.

What is a prediction market?

A speculative market designed so that prices can be interpreted as probabilities used to make predictions.

How can prediction markets indicate a candidate's winning probability?

If a candidate's share price is $0.75, it indicates that traders believe there is a 75% chance of that candidate winning.