How prices are determined in the market

This AE is probably best for a principles of microeconomics course, but could be used in higher level courses as well. Students should understand how markets work and know about price controls. This is a relatively short AE and should be able to be completed in a single class period with time to spare. It is an independent AE and does not explicitly depend on other AEs.

Overview

This AE is designed to get students thinking about how prices are determined in a market. It is based on common misconceptions that many students have about how prices are determined: that producers alone determine prices, and that the government can fix the issue of undesirable high or low prices by using price controls. Students are given a scenario that is likely familiar to them - a rise in price of gas near a holiday when many people take road trips. They are asked who is more to blame for the issue.

Expected Student Learning Outcomes

- Explain how markets determine prices through the interaction of supply and demand.
- Demonstrate how price controls do not necessarily result in the anticipated outcome and leads to an excess demand or shortage.

Information Given to Students

It's memorial day weekend, the unofficial start of summer for most of the U.S. Many families are ready to hit the road for a long weekend getaway. You and your friend are also planning a road trip. When you arrive at the gas station to fill your tank for the trip, you discover that the price of gas has increased significantly since you last filled your tank approximately a week ago. Your friend complains that gas station owners are greedy and always "jack up their prices" like this whenever you take a road trip around a holiday. "It's so unfair – there oughta be a law!" she claims, "The government should stop them from raising their prices so high, especially on a holiday weekend." Thinking back on what you have been studying in your economics class, you consider her claim before responding. Who's most to blame for driving up the price of gas?

A. Greedy gas companies for raising the price of gas right near the holiday.
B. The holiday road-trippers themselves are to blame because they have caused a spike in the demand for gas.
C. The lazy and ineffective government for not stepping in and placing a limit on how high the price of gas can be.

Be prepared to explain why you selected your answer, and to illustrate that answer on a graph showing supply and demand in the gasoline market.

Resources (article, video, etc.)

You might introduce the problem by showing a short video about rising gas prices around memorial day, such as this one:
http://fortune.com/2018/05/21/memorial-day-2018-gas-prices/, but it could be more effective if you simply dive right into this AE at the beginning of class so that you don't end up with a class full of correct answers.

Facilitation Guide

Prefatory remarks:
The key is to get students to understand that it is not just sellers setting prices, but the interaction of both supply and demand in a market which determines price. Here, it would be important for students to see that the increase in demand for gas around a holiday when many people are planning to travel is likely to increase the price of gas. Furthermore, it is necessary in order to incentivize gas producers to be willing to meet the rising demand by increasing their quantity supplied. If the government imposes a price ceiling on gas, it will likely interfere with this incentive from the market.

Debriefing notes, including discussion questions:
It's important to make sure that students see that there are two sides of the market at work here. But, there are opportunities to discuss related topics here as well. For example, the effect of price controls on a market (if the government were to place a price ceiling on gas) might come up in the discussion. And market power could also be discussed (if students recognize that the gas industry is likely not perfectly competitive ). The effect of an excise tax on gas on the price of gas, as well as who bears the cost of that could be discussed. Or students might discuss how additional restrictions on gasoline during summer months to help with pollution abatement come into play here – this could also lead to discussions about negative externalities associated with driving. There are likely many different directions to take this discussion, making it useful at several points in the course .

Closing remarks:
Make sure that students understand how both supply and demand work together to determine prices in a market , and have some working knowledge of price controls. If you discuss any of the other concepts listed in the previous section, be sure to discuss the benefits and costs of any market failures and/or government interventions in this market.

This AE is best fit within a unit on supply & demand, and price controls. Any assessments used for such topics would be effective here.