Analyze the role that prices, incentives, and profits play in determining what is produced and distributed in a competitive market system.

To understand what motivates individuals to behave the way they do in a free market economy, you need only think about the last time you earned money. What did you do to earn it? What did you do with the money? As you answer these questions, you are thinking about economic incentives, profits, and prices. Suppose that you work at a fast food restaurant. Your wage represents the hourly rate at which you are willing to work and at which the restaurant can still earn a profit.If a restaurant paid its employees too much money, it would not break even—it would lose money. If it did not offer to pay people enough money, no one would work there.

Beyond the balance between your willingness to work and your employer’s willingness to pay you, there are economic decisions to be made once you get your paycheck. Once taxes are paid, you are free to use your money as you see fit. If you want to buy a new pair of shoes, another balancing game commences. You would prefer to get your shoes free, but since there aren’t very many stores that give shoes away, you will look for the shoes that you want at the lowest possible price. The “right” price for a good or service in a free market economy is the most you are willing to pay for the shoes and the least the producer or store is willing to sell them for.

Remember, economic theory assumes that all individual behavior is motivated by utility maximization. People want to get as much satisfaction as possible from their work and money. For example, imagine you had two job opportunities that paid the exact same wage, but one of them was much more enjoyable to you. You would most likely take the job you enjoyed, because not only would you be earning a good wage, but you would also “earn” the satisfaction of doing a job that you like. As this example illustrates, it is important to understand that not all the benefits of economic decisions are monetary. In every case, however, individuals calculate the amount of time, energy, effort, money, or other resources they are willing to expend on a particular activity, job, product, or service. If the value they will get from the expenditure is at least equal to what it will cost them, they will probably make the transaction.