Chapter 4

Higher gasoline prices would likely raise the price of large, gas-guzzling automobiles. a) true b) false

False.

The Yankee Candle Company, in Hatfield, Massachusetts, makes thousands of scented candles each day. The factory emits the odor of the candles it produces, some of which smell quite nice. On days when they make strawberry candles the townspeople really enjoy the smell. On days when they make potpourri scented candles, people close their windows and don't go outside. What can we infer about the scented candle market? a) bandc. b) Strawberry candles are more expensive than is socially optimum. c) Potpourri candles are priced too low to be socially optimum. d) Candle production generates only negative externalities. e) Candle production technologies are inefficient.

A. The production of strawberry candles are producing positive externalities - citizens really enjoy the pleasant aroma; however, the production of potpourin candles cause negative externalities - citizens curtail their time outdoors and shut up their doors and windows. Given that these externalities are not accounted for in the costs of production, conclude that strawberry candles are priced above the socially optimum level (under allocation of resources) and potpouri candles are priced below the socially optimum level (over allocation of resources).

If consumers switch away from eating margarine at the same time that the number of margarine suppliers increases, then: a) these two effects cancel each other out and there is no change in the margarine market equilibrium. b) the demand curve shifts left and the supply curve shifts right. c) there is a margarine price increase. d) there is an excess demand for margarine. e) the equilibrium quantity of margarine must increase.

B. Consumers switching away from margarine is a decrease in demand (leftward shift); more margarine producers is an increase in supply (rightward shift). Note: A decrease in demand results in both lower equilibrium prices and quantities. An increase in supply results in lower equilibrium prices and higher quantities. Since the changes both have the same impact on prices, a simultaneous decrease in demand combined with an increase in supply will result in lower equilibrium prices but the overall impact on quantities will depend on the magnitude of the shifts of the curves.

Which of the following is not an example of an externality? a) Drunk drivers raise everyone's auto insurance premiums. b) The price of lumber increases as lumberjacks' wages increase. c) The neighbor's beautiful front yard increases your home value. d) Someone drives a car that emits thick black smoke. e) People who live near a bakery enjoy the smell of baked bread.

B. Externalities are costs or benefits imposed on people other than the consumers and producers of a good or service. In other words, externalities impact groups (e.g., society) other than those who are directly engaged in the transaction (e.g., consumers and producers). Recognizing this, option (b) is not an externality because it involves only those involved in the market for lumber.

Suppose a new law requires all piercing studios to pass tougher licensing tests and to begin using more costly sterilization methods. Other things constant, this law would cause: a) an increase in the supply of piercings and a lower price for piercings. b) an increase in the supply of piercings and a higher price for piercings. c) a decrease in the supply of piercings and a higher price for piercings. d) a decrease in the supply of piercings and a lower price for piercings.

C. The new law would increase the cost of operating a piercings studio - increases in costs of production cause supply to decrease (shift to the left). A decrease in supply results in higher prices and lower quantities.

Over a ten year period, the monthly charge for cellular phone service decreased from $120 per month to $30 per month. At the same time, the number of subscribers increased from less than 10 million to more than 75 million. Which of the following provides the best explanation for these changes? a) An increase in consumer income over this ten year period b) A reduction in the price of residential phone service, a substitute for cellular phone service c) An increase in the wages of workers in the cellular phone industry d) Technological improvements that reduced the cost of supplying cellular phone service

D. The situation above identifies a new equilibrium with lower prices and higher quantities - which would be the result from an increase in supply (rightward shift). Since reduced costs of production will shift supply to the right, option (d) is the correct answer. Note, option (a) is an increase in demand which would result in higher prices and quantities; option (b) is a decrease in demand which would result in lower prices and quantities; and option (c) is a decrease in supply (higher costs of production) which would result in higher prices and lower quantities.

Assume a ceiling price is set above the equilibrium price. The eventual result is a shortage. a) True b) False

False. Price ceilings are maximum selling prices - in other words, the price ceiling is the highest price a consumer would have to pay for the product. Price ceilings are typically used when the government feels the existing market price is to high; thus, to be effective, the ceiling price would be set at a price lower than the existing equilibrium price. Setting a ceiling price above the existing (or current) equilibrium price would have no impact on the market.

If the demand curve increases while the supply curve remains unchanged, the equilibrium price would decrease. a) True b) False

False. When demand increases (shifts to the right) and supply remains unchanged, both the new equilibrium price and quantity will be higher.

Either an increase in demand with the supply curve held constant or a decrease in supply with the demand curve held constant will raise a market's equilibrium price. a) true b) false

True. An increase in demand (rightward shift) results in a market equilibrium with higher prices and higher quantities (intersection of new demand with supply is to the right of original equilibrium). A decrease in supply (leftward shift) results in a market equilibrium with higher prices and lower quantities (graphically, the intersection of new supply with demand is to the left of original equilibrium).

Assume demand is held constant and supply increases. The result is a decrease in the equilibrium price and an increase in the equilibrium quantity of the item bought and sold. a) true b) false

True. An increase in supply (shift to the right) results in a new market equilibrium with lower prices and higher quantities. a) true b) false