ECO FINAL

By giving up $100 of present income for $105 of consumption rights available in one year, a person gets what rate of interest?

5 percent.

If you consume all of your income for two years, what will be your wealth at the end of two years, if it is $10,000 now with 5 percent interest?

$10,000, and it will stay at that value.

What present amount is equivalent to $1,000 paid at the end of each of the next three years at 8 percent interest? That is, what is the present value of a $1,000 three-year annuity at 8 percent interest?

$2,580

You borrow $1,000 today and agree to pay the loan in five equal annual installments at 10 percent interest. Using table 31.A1, determine the amount of each payment, the first payment to be due in one year.

$264.

If your income from nonbusiness wealth is $5,000 a year, what is your nonbusiness wealth at 10 percent interest?

$50,000.

You invest $350 today. At the end of one year you will get back $385. What is the implied or effective rate of interest?

($385 − $350)/$350 = .10; so it is 10 percent

As we have seen, the demand curve for investment is negatively sloped with respect to the rate of interest—that is, at higher rates, investment will be less profitable. Why is this implied by the earlier propositions on behavior of costs?

A higher rate of investment means a higher rate of production of some goods which involves using existing resources more intensively or for longer intervals and hiring more less-productive (higher marginal cost) resources. This implies a higher cost per unit of those goods.

"The progressive deterioration in the value of money throughout history is not an accident, and has behind it two great driving forces—the impecuniosity of governments and the superior political influence of the [672] debtor class. . . . The power of taxation by currency depreciation is one which has been inherent in the State. . . . The creation of legal tender has been and is a government's ultimate reserve; and no state or government is likely to decree its own downfall, so long as this instrument still lies at hand unused" (J. M. Keynes, A Tract on Monetary Reform, London: Macmillan and Co., Ltd., 1923, p. 9). Explain in more detail what Keynes meant

According to the quotation, two groups—the government and other debtors (net monetary debtors)—benefit from inflation and are the driving forces behind it. Inflation is a tax on money. Inflation is caused by increases in the supply of money (currency), which is controlled by the government. If the money stock doubles and the amount of goods and services remains about the same, prices eventually double. The government, which makes purchases with the new money before prices rise, benefits from the inflation tax since real resources are transferred to it at the lower prices. The government and all other debtors benefit from inflation to the extent that it is unanticipated. If loans were made and bonds issued while assuming no inflation (so that no adjustment could be made in the interest rate for the inflation), the dollars repaid to the creditors after the inflation would be worth about half of their original value—they would purchase about half the real goods and services they would have before the inflation. There is a shift in real resources to net monetary debtors from net monetary creditors.

Does storage from one crop season to the next season occur because people are farsighted and contemplate their own future demands, or is it done because people think they can make a profit?

Primarily for profit. In pioneer days, households canned fruits and vegetables in harvest season for their own later consumption. Commodity exchanges achieve a similar outcome for an entire economy, although the motives of the "speculators" are merely to earn profits

"Open speculative markets are defended on the premise that it is better to be aware of impending events than to be unaware of them. But for events like impending crop disasters, earlier news merely shifts forward the effects and thereby spreads them over a longer interval, to no one's benefit. People might prefer to experience a short, intense period of less coffee in the future rather than have an earlier, longer-lasting though less intense reduction in consumption." What does economic theory say about this?

Bidding up present prices reduces the quantity currently demanded, leaving more to be consumed in the future at lower prices than if the earlier prices were unchanged. A speculator can choose the combination of risk he wishes to bear. The more the speculator chooses to buy and hold for the future, the more he stands to lose if prices do not rise.

"Scarcity, competition, and discrimination are inextricably tied together. Any one implies the other two. Furthermore, to think of a society without these is to be a romantic dreamer." Do you agree?

Choice of one thing versus another occurs because there is scarcity; competition and discrimination occur even in an imaginary world of no money, no prices, and no markets. As we will see, suppression of market-determined prices of goods and services gives rise to nonmoney forms of competition and discrimination.

Almost every year, someone proposes that Congress enact legislation "to create more jobs." Of course, Congress doesn't create jobs: there are already too many jobs to do, and the jobs it presumes to create already exist as useful things to do. What is Congress really being asked to create by that legislation? ⚓ ✪

Higher wages than are now available for those jobs.

For what events is the distribution of risk the same in socialist and capitalist systems?

How about divorce, cancer, baldness, homeliness, having only male children, being left-handed

Suppose that for all the people in the bottom quartile of incomes in one year, you computed their average income that year and compared it with the average of those same individuals in the next year. Do the same for the top quartile. Which group will show a rise and which will show a fall?

The average income of those people who were in the lowest quartile will be higher in the next year, while the income of the individuals who had been in the top will fall on average. This reflects the universal regression effect.

"If savings is defined as an increase in wealth and if investment is defined as an increase in wealth, then savings by definition is always equal to investment; for it is merely the same thing looked at from the point of view of two different people." Since this statement is correct, how is it possible to speak of equilibrating the rate of investment and the rate of savings?

Investment is defined as that rate of conversion of present income to wealth which can be profitable. That rate is related to the rate of interest in the investment-demand function. Saving is defined as the rate of conversion of present income to wealth that the community wants to engage in. The rate at which the community is willing to divert income from current income to wealth accumulation is a function of the rate of interest (among other things), and this relationship between the savings rate and rate of interest is the supply-of-savings function.

Who is substituted for whom when a firm uses a computer-controlled robot rather than employees to perform some repetitive task in manufacturing? This is often called a "substitution of capital for labor." Why is that misleading?

Labor used to make the computer, the software, and the robot is substituted for the manufacturer's employees. Substitution of "capital for labor" can be misleading, because it ignores the labor used to make the capital.

Do you think specialization will be carried to a greater extent in a large city or a small one? Why? Give examples of what you mean by greater specialization.

Large. Greater variety of relative talents and training so that differences between people's relative abilities are more common. Further, the larger market enables a person to sell more of his special output at profitable prices. Greater concentration of time on same repeated subtasks. For example, hair shearing for poodles only; architects specializing only in certain types of buildings; greater number of specialty shops such as medical specialties—foot specialist, ankle specialist, knee specialist.

Consumption is a rate concept, even though the good being consumed may be held as a stock of goods. True or false?

True.

A governor of California once asserted that the reduction of Mexican labor in California (as a result of the end of the guest worker program) did no harm, because the total value of the crop harvested was larger than before. Evaluate the relevance of that criterion.

Welfare change is not measured by total market value of the entire crop. If demand elasticity is less than one, bigger supply will lower total market value (total market revenue) while total personal worth increases because of larger supply (larger total worth measured by total area under the relevant [80] portion of the demand curve). Do not confuse total personal worth with total market-exchange value (market sales revenue). Total personal worth is closer to a welfare criterion.

"Economic theory is applicable only to a capitalistic society." Evaluate.

he market-exchange system characteristic of private property (capitalism) has been the dominant institutional context of the preceding chapters. But the economic theory used there is applicable to any system of competition—resolving conflicts of interest among people arising from the fact of scarcity.

One person owns a baseball team and the stadium; another owns the adjoining parking lot. Might there be a conflict of pricing strategies—admission to the game and parking—of the independent owners? Can't each of them seek his own profit-maximizing price?

Each can seek, but perhaps neither will find. Each hopes to set his price optimally, given the price selected by the other. But each could wish that the other would lower his price, preferably to zero. And any change in the other's price, up or down, will affect the circumstances in which his own price is determined.

"Automation is destroying jobs." Is destroying jobs socially good or bad? Explain why it does not mean that anyone will be left without a job.

Earlier labor used in creating capital equipment is being substituted now for workers who used to perform the tasks. The displaced workers are available to work at other jobs, which may be less valuable jobs and have lower wages. The high-wage people who designed, built, and programmed robots to ice cookies in the bakery displaced the lower-wage people who formerly iced cookies by hand.

"Money is a medium of exchange. It is a common denominator or measure of value. It is a store of value. The first two are relatively unique to money, whereas the last is not." Explain what is meant by each sentence.

Most exchanges involve money as one of the goods, and the exchange rates are expressed in terms of money. Use of money prices makes it easier to compare the worth of disparate items, like a pair of shoes and a loaf of bread. But many nonperishable goods have values that persist over time.

"It's better in theory than in practice." What do you think this means? Do you agree?

"It's a good theory but it predicts badly." Disagree. If the theory predicts badly, it's not a useful theory. A useful theory predicts well—the theory makes implications that are confirmed or supported by events.

"Long ago we stated the reason for labor organizations. We said that they were organized out of the necessities of the situation; that a single employee was helpless in dealing with an employer; that he was dependent ordinarily on his daily wage for the maintenance of himself and family; that if the employer refused to pay him the wages that he thought fair, he was nevertheless unable to leave the employer and resist arbitrary and unfair treatment; that a union was essential to give laborers opportunity to deal on an equality with their employer" (Charles Evans [642] Hughes, Chief Justice, Supreme Court of the United States, from the decision in United States v. Jones and Laughlin, 1937). Evaluate the above propositions for their meaning—or are they wrong or vacuous? ⚓ ✪

All the statements are empty, wrong, or irrelevant. That many sentences written about unions are empty, wrong, or irrelevant in no way implies that unions are useless, wrong, or misunderstood. An employer must pay wages that are high enough to attract workers from other employers. The individual worker (price-taker) acting alone cannot change the wage rate by withholding his services; however, the employer must offer the worker wages and working conditions attractive enough to attract the worker away from other potential employers and offers.

During periodic energy "crises," people are told that unless more energy is conserved or made available, jobs cannot be preserved. Such statements are incorrect. Certain jobs would in fact be increased by a reduced supply of energy, for there would be more work for people to do! What do you suppose people mean, or should mean, by saying that jobs cannot be preserved?

At higher energy costs, some jobs would be less valuable. Payment for those labor services would fall as the value of those jobs were revised downward. Some people could be laid off as the firms downsized in response to rising energy costs. More, not fewer, jobs would be available—however, most would pay less. The speakers/writers mean that fewer jobs would be available at the higher wages associated with the prior lower energy costs. With more costly energy, the community would be poorer.

Explain how bank owners (stockholders) as a class suffer from inflation.

Banks are net monetary creditors. Part of the equity or net wealth, represented by this amount of net monetary assets, does not rise in proportion to the price level.

Are higher costs of training the reason why earnings in some occupations are higher?

Costs of training affect both the demand for the services in question and their supply. Potential buyers (employers) will assess the likely value to them of the services partly in light of what is known about the previous training of the employee, with increased demand in light of greater training. And higher costs of training restrict supply, shifting the supply curve to the left, intersecting the demand curve at a higher wage. The wage is given by the demand price at the amount supplied

Instead of playing computer games, a man works around the house painting and refinishing the walls. Explain why this is a form of investment.

Current consumption (leisure, watching TV) or some alternative, less-valued investment activity (reading an economics textbook, picking stocks to purchase) is forsaken for future income from the preserved house.

As a summer-job-seeking college student, are your chances of getting a job increased or decreased if the wages you can get in a summer resort, as a babysitter and so forth, are enforced by a union comprised of current full-time employees?

Decreased. The union will seek higher wages to keep only full-time employees (its members) at work, with less interest in casual, inexperienced, seasonal laborers. And a higher wage will lead employers to shun less productive workers.

During the final years of the former Soviet Union, top government officials decided they must introduce "private property rights" that they saw were common in the more successful market economies. After only one year, they boasted, "Moscow has the highest incidence of home [374] ownership in the world." However, selling and buying houses was still prohibited. What were the Soviet leaders not understanding about home ownership?

Exclusive use of something—whether living in a home or using the desk and computer provided by your employer—is not ownership. Property rights include both exclusive right to use and the right to transfer exclusive right to use to another party. Where open markets are not permitted, possessing a "certificate of ownership" has little meaning.

"More of a public good can be produced without the production of other goods being curtailed." Evaluate.

False; it is the consumption of the good that is referred to in the definition of a public good. Once the good is produced, any person can have as much as he or she wants without reducing the amount to anyone else.

What is legal tender? A $10 Federal Reserve note says, "This note is legal tender for all debts, public and private, and is redeemable in lawful money at the United Sates Treasury or at any Federal Reserve Bank." If you ask the Treasury to redeem that note for lawful money, what will you be given?

If the courts of a country will require payment in a certain currency as a result of a judgment or settlement, that currency is legal tender. If you win a court case in which a seller defaulted on his agreement to deliver gold to you, the court will require simply that you be paid an amount of US dollars in settlement of your claim. So the court is not treating gold as money—legal tender. The Treasury might give you another $10 Federal Reserve note, or two $5 notes.

If in some town the minimum wage rate for taxi-driver employees were raised to $50 an hour, what would happen to the ratio of cabs driven by the owners to cabs driven by employees of cab owners?

Increase. Self-employment is a way of evading wage regulation

Drying grapes to convert them to raisins is investing. Why is this investing, since it merely changes one form of consumption good to another form?

It permits more future consumption at the cost of less current consumption. But consider carefully what is meant by "more" and "less." One grape makes only one raisin, and drying the grapes removes water, so 100 raisins weigh less than 100 grapes. But in economics, more refers to value or worth to the consumers—not a physical amount of something

In what sense is insurance a one-sided hedge?

It usually protects against large losses, without giving up rights to large gains

"The presidents of some big corporations are paid over $1,000,000 in one year. They make the kinds of decisions that are made in thousands of other companies by much lower-paid people who are as intelligent, but who haven't had a chance to get those fancy jobs and who aren't as well known. Salaries are based primarily on past experience, reputation, and pull. Therefore, marginal productivity—which is an academic, unrealistic abstraction of an imaginary world—is misleading at best and false at worst." Explain why the last sentence is not implied by the preceding sentences.

Marginal productivity of a resource affects its reward, and the amount of capital used with it affects its marginal productivity. Consider two managers, one of whom has the ability to make correct decisions about 5 percent more of the time than the other. For a $1,000,000 company, this difference would amount to about $50,000, whereas for a $100,000,000 company, this difference would amount to about $5,000,000. Clearly, the larger company will gain more with a superior manager than would a smaller one. Standard workers would not be making decisions that affect company wealth as much as do top executives, so the difference in their talent would not be magnified as much as those of top executives. As a result, pay of nonmanagerial personnel would be about the same in small and large companies while pay of top executives would be related to the size of the company.

"Middlemen and the do-it-yourself principle are incompatible." Explain.

Middlemen facilitate exchange and specialization, while "do-it-yourself" is a reduction of specialization and exchange—"eliminating the middleman" who economizes on transactions costs and doing it yourself is not necessarily cheaper. (This doesn't mean that it's not ever cheaper to "do it yourself"—to the contrary, look at the home improvement industry.)

What is meant by "the demand for money"? Money itself is not eaten, worn, or otherwise consumed; so, except for the miserly joy of running through it in one's bare feet, what gains can there be in not spending all money on consumption as soon as it is received? ⚓ ✪

Money is used to facilitate trade by economizing on transactions costs (so you don't have to carry around other items that other people may want in exchange for what you want to purchase), it's a store of value, it's easily recognizable, it's portable (easy to carry around), and it's durable. Sometimes the terms of an exchange are different when it is "all cash" from the buyer to the seller.

"Invention and the lower cost of power in the home have replaced the domestic servant by capital equipment. Without that machinery more people would be working in homes as servants. But the replacement of domestic employees by capital has not led to the replacement of labor." Why not?

New opportunities for labor—including making home appliances—were created. The laborers did not disappear. Released from their domestic roles, they were used elsewhere.

If you own and drive an automobile, you are required by law to have some minimum amount of insurance in case of accident. Suppose the law in the state where you live were changed to require all minimum automobile insurance policies to include a quarterly oil change and tire rotation. Is that really "insurance"?

No, the requirement for "insurance policies" to include such routine pre-paid maintenance is not a feature of insurance. The cost to you of such a policy will reflect the costs of these services. Similarly, when government requires that "health insurance" policies include such services as regular physicals, mammograms, birth control, and so forth, that is not insurance. Even if you do not make a payment to the doctor for these services, they are not "free" to you. You have already paid for them in the higher price you pay for the insurance policies that include these services.

Is a person who loses his job through no fault of his own also unemployed thereafter through no fault of his own?

No. He chooses not to accept the best alternative job he has so far discovered, and is instead looking for options, which is not to say that he is lazy, irrational, or deserves to be poorer. Time spent searching for employment can be wealth-enhancing.

"According to the law of demand, the lower the price of vacations, the more vacations I should take. Yet I take only one per year. Obviously the law of demand must be wrong." Is it?

No. I may take longer vacations. Or, the length of my vacations does not change, but they will be more elaborate or exotic

"That speculators push up the price of a good is evidenced by the fact that the price often rises before there is any change either in the rate of consumption or the existing supply." Do you agree?

No; in a system with secure private property rights and open markets, prices rise or fall at the time expectations of the effect of a future event on a resource change—not at the time the event occurs. It's not that the speculators "push up the price"; it's the events that cause the change in expectations that cause the higher prices.

Your uncle has died, and your aunt has collected his life insurance and asks your advice on investing the money. She wants to buy stock in a company that will give her a very high return, and she does not want to take any risk. What advice do you give her? ⚓ ✪

Patiently and gently, explain that there is an unavoidable trade-off between risk and expected return. It is not possible to find an investment that promises to give her a higher-than-average return and a lower-than-average risk. Her best choice would be investment in a diversified mutual fund of many different companies.

"Different workers receive different wages because the workers are different, the jobs are different, and workers can't move to other jobs easily." On the other hand, "Workers are different but get the same pay [625] in many jobs; many different jobs pay the same wages; and it is about as 'easy' to move across the country as it is to move next door." Where lies truth? Write a better version of the line of thought.

People differ in their productive abilities and in their costs of acquiring skills. The cost of acquiring skills (cost factors that restrain one person's ability to duplicate that of another) are such that wage differentials can exist. These wage differentials commonly will be smaller than the costs of acquiring skills that would enable lower-paid workers to do the work of higher-paid people. Except for fortuitous matching of demands and supplies at wages equal in all tasks, differences in wages will persist, but they will be less than the costs of acquiring skills of higher-paying jobs and/or transfer costs.

There are two kinds of economic efficiency—cost minimization and profit maximization. In what sense is profit maximization a more general criterion of efficiency?

Profit maximization compares value of what is produced with the cost, rather than merely minimizing cost of what may not be worth even that cost.

At the end of a year you will get $220. At a 10 percent interest rate, what present amount will grow to that amount? In other words, what is the present value of $220 deferred one year at 10 percent?

Refer to table 30.2, present value of $1. At 10 percent, the present value of $1 deferred one year is now $.91. Therefore, the present value of $220 deferred one year is $220 × .91 = $200.20.

At some colleges, students seek membership on committees that appoint or terminate faculty members. The faculty usually contends that employment is a matter best judged by qualified people like other faculty members. Students contend that the faculty chosen affects their lives, and hence they should have a say in the matter. Perhaps students already have more power than the faculty. Explain.

Students as a group (and parents who pay most of their expenses) have more power than faculty in the sense that they select which colleges to attend, what fields to major in, and which classes (professors) to take. Payments for tuition, room and board, textbooks, and other expenses reflect these decisions. Over time, colleges that are not responsive to the demand of the students and their parents will lose applicants and enrollments. The quality of applicants and enrollments of these schools will decline, further affecting the school's reputation and ability to raise funds. All of this will affect hiring of new faculty and the advancement of existing faculty [655] members. As students switch majors from one field toward another, the faculty in some fields will be expanded relative to others. Within a field of concentration, word spreads among students who the better teachers are, and more students register for those classes and try to avoid "unpopular" teachers, ultimately affecting which classes are expanded and which are cut back over time.

At one time, the National Teachers Federation, a teachers' union, advocated a single salary scale, wherein every teacher, regardless of specialty, gets the same salary in the first year of teaching, with salary thereafter tied strictly to years of service. Who would benefit and who would suffer if that were made universal: Men or women? Superior or inferior teachers? Mathematics or physical-education teachers?

The losers are those who would have advanced more rapidly because of personal superiority in job performance as judged by superiors. We conjecture those who would have advanced relatively rapidly are men, superior teachers, mathematics teachers. (What is your conjecture? If we differ, is it in principles of analysis or in estimation of attributes that would lead to more rapid advance?)

"The fact that some airplanes sometimes collided in midair is evidence that there was too little air traffic control." Evaluate.

The mere statement of the fact does not justify the conclusion. It may or may not be reasonable to judge that there was too little traffic control, but to remove all risk of all accidents costs more than it's worth—that is, the only way to eliminate all such risk of accidents would be to ban flying

You are interested in buying the stock of either one of two companies. You look up the history of their respective prices over the past year and find that one has risen 10 percent, so it is now more expensive than it would have been a year ago, while the other has fallen 10 percent, so it is now cheaper to buy than it would have been a year ago. Does this help you in deciding which stock to buy?

The past history of the stock prices is not helpful information; the prevailing price of each stock reflects the collective judgment of market participants about the future of the companies. Buying one stock because "it is now cheaper" or buying the other because "it rose a lot last year" would not [569] be valid reasons for choosing between the two. Only new information will cause either stock price to rise or fall from today's price.

Recently, the Chicago Board of Trade reported the prices ($ per bushel) of wheat futures contracts for the following months: ⚓ ✪ May $7.25 July $7.20 Sept $7.24 Dec $7.34 In what month does it appear that the new crop is harvested? Explain the basis of your answer.

The prices of the contracts suggest supply will increase in July (relative to demand), resulting in a lower price. The higher price in December suggests this market is pricing in a relative decline of new supply versus demand.

In order to stimulate more investment in "green energy" such as solar-panel and windmill generation of electricity, governments in North America and Europe provided guarantees against loss to investors who would lend to such enterprises. What does economic analysis suggest would be the consequences of such taxpayer-provided guarantees?

The risk premiums in such guaranteed loans have been much lower than otherwise, so the interest expense to borrowers has been artificially low. Decision makers in the solar and windmill businesses borrowed much more than otherwise and approved projects that had low probability of profitability. Over-investment (in economics, often called mal-investment) in energy-generating projects that require taxpayer subsidies results in lower standards of living. Losses incurred by such projects are paid by taxpayers. Also, the resources employed by money-losing projects could have been employed in more productive ways. Economics does not say that such choices are bad or undesirable, only that people will be poorer as a result

Evaluate the statement: "When property rights conflict with human rights, property rights must give way."

The statement is vacuous. Human rights are the rights of people to use scarce resources. The property itself has no rights.

When requesting a Congressional investigation into the methods, charges, and quality of services of private employment agencies, a former president of the United Steelworkers of America said, "A man or woman should not have to pay—often a large sum—for the privilege of obtaining a job." He also asserted that society and government had an obligation to make it possible for "every willing and able individual to work at or near his highest skill." Evaluate those remarks

The unemployed can obtain jobs rapidly—at sufficiently low wages. However, most workers do not take the first job offer if it is below their reservation wage (what they think they can get). Obtaining reliable information about available jobs is expensive for job seekers (as is obtaining information about employees for employers). What job seekers pay [613] employment agencies for is costly information. In an open-market, free-enterprise society, the unemployed have the opportunity to search among potential employers for the best opportunity available to them, given their competence and accomplishment.

During a strike or labor-dispute negotiations, the government sometimes appoints an investigating panel composed of representatives from the union, the employers, and the consuming public. Which especially affected group is not represented on these panels?

Those people who would be willing to work at open-market wages and who do not belong to unions.

During the period of rapid inflation in the United States in the late 1970s, interest rates on loans and bonds were adjusted accordingly, to about 15 to 20 percent. Two decades later, inflation was substantially reduced to about 2 percent. Who gained and who lost during the transition from high to low inflation?

Those who bought bonds when inflation and the coupon interest rate were high experienced a considerable wealth gain with lower interest rates from falling inflation. Those who issued the bonds when inflation and interest rates were high suffered a wealth loss

"The higher the legally constrained minimum-wage rate, the greater the amount of unemployment of unskilled workers." Is this correct?

Those who cannot provide labor services worth as much as the minimum-wage rate will lose wage-paying employment and will have to work as self-employed or commission-basis employees. Thus, in saying that a higher minimum wage reduces employment, we mean employment for wages—not work in industries and sectors not covered by minimum-wage legislation, or where labor services can be offered by "self-employed" contractors.

Does the value of money depend upon what it is made of or upon its quantity?

Value of money is what you can exchange or trade l unit of the money for—you could trade one dollar for one quart of ice cream, or one cup of [670] coffee, or one loaf of bread. The value of money depends also on the total quantity of money in existence. If the stock of money doubles, after adjustments occur, prices would about double. Then one dollar would trade for only half as much as before.

At one time it was said that the steelworkers' union and the US Steel Corporation were both monopolies. In terms of the closed and open monopoly distinction, was that correct?

Yes, but the union is not an open-market monopoly and US Steel was. (With respect to the world open market, both are closed-market monopolies as a result of immigration laws and tariffs on imports.)

You have been following the stock prices of a company you like, and are trying to decide whether to purchase the stock. You decide to call different stockbrokers and investment advisors to ask their opinion of the current price. One half think the price is too high, and one half say it is too low, and not one says the current price is just right. Does that make any sense?

Yes. A prevailing market price does not mean that a single person on the planet thinks that price is in any way "correct." The current price always means that one half of market participants (weighted by amount invested) think it is too high, and one half think it is too low. New information will cause some to revise their opinion, and the price will rise or fall.

Barriers to labor competition: a. Labor groups were strong advocates of raising barriers to immigration in the nineteenth century. Employers objected. Why? b. ⚓ ✪ Labor groups were less enthusiastic in support of tariffs (taxes on imported goods), but some were in favor of them. Why?

a. ⚓ ✪ It would have reduced the number of laborers and raised wage rates. Today, many unions continue to oppose "guest-worker programs" for immigrants to temporarily work in the United States. b. Producers (employers and employees) of goods that could be obtained [640] more cheaply by importation wanted tariffs. Tariffs would raise the price of the imported products relative to domestically produced products. In some industries, unions claimed that it was "unfair" that their members had to compete with less-well-paid foreign workers.

At a time when it was being debated whether to maintain the military draft or switch to a volunteer system, an official Defense Department study reported that the elimination of the draft by raising wages to enlistees would cost about $5-$15 billion annually. Therefore, the Defense Department in view of that prohibitive cost is recommending continuance of the draft. ⚓ ✪ a. Explain why the first sentence is incorrect. b. Would you be willing to assert that raising wages to abolish the draft would reduce costs?

a. Draftees were forced (prison was the potential penalty for refusing the draft) to leave jobs, education, or other activities in which they would otherwise be engaged. The statement only meant that eliminating the draft would raise the payments the federal government would have to record in its budget. Real costs are paid by those who are drafted (and the consumers of products and services that the draftees would have created). By eliminating the draft, military personnel were recruited by paying adequate wages to attract men whose opportunity cost in doing other things was lower than their value to the nation as soldiers. ⚓ ✪ b. You should, since it will. By better assignment of people to jobs in this country—resulting from using adequate wages for military personnel—the total productive efficiency and output was increased, so our sacrificed output became smaller. The draft system concealed costs—by making federal expenditures lower through the device of compulsory service—just as police-department costs could be made to appear lower if police were drafted.

A former head of the auto workers' union contended that automobile producers should lower their prices to benefit the public. ⚓ ✪

a. That would have lowered the price of foreign imported cars relative to autos produced by US manufacturers. At those lower prices, foreign manufacturers would have sold more autos in the United States. Members of his union would have to switch to lower-paying jobs. b. ⚓ ✪ At relatively lower prices consumers would purchase more cars produced by union members. While the advocacy of lower prices was said to be for the benefit of consumers, it actually was intended to benefit producers (workers) who made cars.

Is Microsoft's browser (Internet Explorer, now Edge) with its operating system a tie-in? Apparently the European Union thinks so. What are its purpose and effects?

A computer operating system that includes a bundle of applications can be thought of as involving tie-ins. For example, Apple includes its proprietary [341] browser, Safari, with its operating system, even though some Apple users may choose to install other browsers such as Firefox. Presumably, the producer believes demand for the operating system will be greater—and revenue and profitability greater—than if all applications were sold separately.

A theatrical producer expressed delight that tickets for his play had been sold out for the next four months. Explain why he might have cause to be sad, rather than happy. ⚓ ✪

A higher price would have induced a smaller quantity demanded. If the price was below the market-clearing level, some increase in price would simply reduce the "shortage" of seats, and all the seats of the theater could still be sold. If the price were raised enough, some seats would remain empty, but if demand were inelastic, total revenue from ticket sales would increase.

It has been estimated that carrying a spare tire on automobiles costs the public millions of dollars every year. Is this a waste of idle resources? What would be the cost if that figure were cut to zero by not carrying any spare tires?

A spare tire—idle resources—is a way of adjusting to uncertainty and unanticipated future changes or "emergencies." If no spare tires were carried, other more expensive adjustments would be made at the time the flat occurred. For example, a taxi or emergency road service could be called—both of which could involve not only the price of the service but additional costs of delay (such as missed or late meetings, appointments, and deliveries). Uncertainty is a fact of life, and information and adjusting to unanticipated changes is costly. Costs are higher for more rapidly acquiring information and adjusting to physical changes

What is meant by equality between private and social costs

All costs are private. Social costs are simply the total of all private costs. If a person does not bear all the costs of his action, then the social costs [44] exceed the total of the costs he bears, because some of the costs are borne by others. With equality of private with social costs, all costs of a decision are then borne by the decision maker.

"With open-market pricing, housing units are scarce or expensive, whereas with rent control the housing market is characterized by shortages." Explain.

All economic goods are scarce; shortages result from prices below the market-clearing level. Possession of nonpecuniary attributes will now play a greater weight in allocative decisions. Over time, housing quality and quantity will deteriorate.

If you don't smoke, is tobacco a good? Are purchase and sale necessary for something to be considered a good?

Although you do not smoke, there are others who want more tobacco products than are available at a zero price. They are willing to trade some amount of other goods to acquire a given amount of tobacco. Tobacco is an economic good, even if you do not think it is good to use tobacco

"The government decides to levy a tax on a commodity. It could tax the sellers of the good and thereby induce a reduction in supply, or it could tax consumers and thereby reduce demand. It is better—fairer and less disruptive—to tax businesses rather than individuals and households." Is this sound public finance? ⚓ ✪

As illustrated in figures 17.1A and 17.1B, it does not matter how the analysis is couched. It can be stated in terms of reducing supply or of reducing demand. In either case, the effects on quantity bought and sold and price are the same, with quantity reduced and the price paid by the consumer rising (by less than the unit tax) and price received net of tax received by the seller falling (by less than the unit tax)—with a deadweight loss to society, because the resources released from reduced production of the good will be less valuable in an alternative use.

Joe bought some land 30 years ago for $5,000; it has a market value today of $85,000. Betty put $5,000 into the stock market at the same time. At what annual rate would Betty's portfolio have had to increase over those 30 years to match Joe's experience?

At a 10 percent rate of stock price appreciation, Betty's holdings would now be $5,000 × 17.4 = $87,000, a little better than Joe's gain.

If you can borrow $1,000 from your college at a 5 percent interest rate for six years, and if you can invest with a 10 percent rate of return, what is the present value of the arrangement to you? Instead of the loan that you have to pay back, you are offered an outright gift of $300. Which would you prefer, the outright gift or the loan?

At a 5 percent interest rate, you will have to pay back $1,340 at the end of six years. If you can invest the $1,000 at 10 percent for six years, you will [486] have $1,770. The difference, $430, is the value of the gift implied by the subsidized loan. If, as an alternative to the loan of $1,000 at 5 percent for six years, you are offered a gift of $300, at any interest rate of 8 percent or more you can invest and have more than $432 at the end of six years, so you would take the gift. (Using table 30.1, you would get: $1,771.56 − $1,340.10 = $431.46.)

An attempt to impose losses on competitors in order to achieve a monopoly position with subsequent "above-competitive" prices would be a predatory action. A case frequently alleged to be a predatory action involved Rockefeller's Standard Oil Company in the nineteenth century, when Standard's low prices in selected local markets were interpreted as devices to bankrupt smaller refiners. Would this be an intelligent tactic—that is, wealth-maximizing—even if no law prohibited it?

Both predator and prey lose wealth, and the bigger firm will take a bigger absolute loss. The smaller firms may shut down production of that item and wait out the return to higher prices. If a firm were to gain by driving a competitor to bankruptcy, the prey's productive assets must be retired. Bankruptcy does not destroy productive resources; they go to someone else, who probably acquired them at a sufficiently low cost to make their continued use profitable. The aggressor, who has been suffering losses to impose losses, would have to continue his predatory tactics as long as required to wear out or absorb the other resources, and this would mean still larger losses. There is substantial evidence that Standard Oil Company bought rivals at a handsome price and retired the productive capacity.

Evidence of the great, but not always helpful, extent of specialization of knowledge is provided by Albert Einstein's assertion (Socialist International Information): "The economic anarchy of capitalist society as it exists today is in my view the main cause of our evils. Production is carried on for profit not for uses." Expose his error in economic analysis.

Capitalist society does not restrain production. Production for profit is production for higher-valued uses—not just anything for any use. Einstein [228] didn't seem to understand what value and costs meant or how they affected profitability.

"Someone always has a comparative advantage in the production of some good." Explain.

Comparative advantage pertains to relative production-efficiency (output/input) ratios of different producers of more than one good. With two producers, unless one is absolutely superior by the same degree in two goods, each will be relatively superior in one good and inferior in the other.

"Unfettered world trade would tend powerfully to reduce all workers (and other resource owners) to the world's lowest level. For a nation with lower wages—and all nations do have wages lower than those in the [210] United States—could then undersell us, not only in third markets, but in our own country. Thus, American producers would be ruined; or, in order for us to be able to sell and thus to survive, our wages would have to be cut to the lowest level of our competitors. It would be ridiculous to expose our high standard of living to the ruinous competition of the poorer rest of the world." How could you dispute this?

Confuses the price of labor (wages) with the cost of producing per unit of product. Cost is the value of output given up per unit of product. American wages of $20 per hour reflect the productivity of labor; they do not measure cost, which involves labor productivity per unit output. At 10 units of output per hour, cost is $2.00 per unit of output. Foreign labor with wages of $5 per hour may produce only 1 unit of output per hour. In this case, higher-wage, more productive American labor is a lower-cost producer than the low-wage, less productive foreign labor.

Simple demand-and-supply analysis suggests very frequent, almost continuous price fluctuations as demand and/or supply fluctuate. But a high degree of anticipated price stability, or price movement within a very narrow range, is commonly observed—and can be advantageous to both sellers and buyers. How can it be that substantial price stability can be a good thing in generally found circumstances, but price flexibility in response to market pressures is useful in other cases?

Constant price movements can be distracting and upsetting to buyers. It would be difficult to act systematically and confidently if each day, as you leave home, you could not well anticipate the prices you will be paying for bus fare, a cup of coffee, a newspaper, lunch at the deli, or groceries to bring back in the evening. Sellers don't want nervous and frustrated haggling customers, so they promote prices which will prevail for some while, advertising and managing inventories to maintain prices which are steadier than the ever-shifting demand and supply forces might indicate, and to build and maintain a reputation of predictability and reliability. ⚓ ✪ Still, prices are not to be set permanently in the face of evolving and sometimes volatile markets. If prices are stubbornly maintained (perhaps by government decree) in the face of sudden, large movements in the equilibrium level, allocation of factors and goods have to be made by non-market devices. Such devices are arbitrary and invidious, although adopted in the name of fairness. If a hurricane suddenly wipes out much of the regional availability of gasoline and a maximum price is imposed below the new, higher market-clearing level to prevent "gouging," (a) there will be vexing problems in rationing the "short" supply, and (b) the artificially low price will discourage movement of outside resources into the blighted area.

Are costs the same thing as the undesirable consequences of some action? Explain why not.

Costs are not the undesirable consequences of an act; they are the highest-valued forsaken opportunity. Anticipated unattractive consequences of a possible action may well play a role in deciding whether or not to pursue the activity or in determining how far to pursue it, but they are not formally a "cost" of the venture

For most of the items you find in the produce department of your grocery store, the packaging, transportation, and distribution costs are a much larger share of the price you pay than the share of the price that goes to the farmer. Is that a fair distribution?

Economics does not help in making judgments about what is fair. The farmer cares most immediately about how much he is paid—relative to his costs—not about what share he received of the final selling price. The same is true of all others who participate in bringing food from the farm to the grocery store. Of course, some people enjoy "cutting out all the middlemen" and incurring the personal costs of traveling to "farmers markets" to purchase fruit and vegetables and transport them home. However, personally incurring such middleman costs does not deny that they exist and must be borne by someone.

"Society—all of us—would be worse off without ethical behavior." "A purely economic analysis is too narrow an interpretation for a full understanding of Good Samaritan behavior." "A society could not well persist without a dominating sense of ethics, honesty, and proper respect for others." Such observations may be expected in philosophy, sociology, psychology, and poetry, but do they belong in economic analysis?

Economics is concerned with pervasive and fundamental aspects of individual and social behavior in a hard, competitive world of scarcity. Economic analysis is more than a dispassionate "logic machine." The basic nature of a society is largely determined and represented by the nature of its economy—and the manner and functioning of an economy is heavily shaped by the character of the society.

"Elasticity is a measure of the percentage increase in demand for a one-cent change in price." There are two errors in that statement. What are they?

Elasticity is the ratio of percentage change in quantity in response to a small percentage change in price. It is "percent," not one-cent. And it is "quantity demanded," not demand.

Many products are produced and then distributed to consumers by separate firms in differentiated but interdependent activity. Each of the firms is looking for profit. But they can disagree significantly on pricing and distribution policies and performances. Why?

Firms at different stages of an activity can have different primary sources of revenue and different concerns about the reliability and effectiveness of their associates in the overall enterprise. Recall illustrations in the text. The newspaper publisher obtains most of his revenue from advertisers, so he likes to keep the price of the paper low (even zero), with large circulation attracting ads; the newspaper vendor gets all of his revenue from sales, so he wants an appropriately high price of the product. Telephone manufacturers want very low prices of telephone services in order to have [388] large sales; telephone service providers seek profit-maximizing prices for usage—and want the manufacturer to make and sell the phone as cheaply as possible. Note the difference in price for a new model smartphone when purchased without a service contract versus the much lower price (or "free") when purchased with a contract. Wholesalers have little love for inept, inefficient retailers who alienate potential customers; retailers have little love for suppliers who alienate potential customers by failing to maintain product quality.

Ralph Nader, a well-known exposer of product defects, complained that a person who relieves himself in a river is fined, but industries that pollute the same river are not. Muggers are punished, but smoggers are not. These he cited as illustrating the inequities and irrationalities of our society and economy in its attitude toward big corporations. What has Nader overlooked?

He ignores the social gains provided by activities that produce smog and pollution as a by-product. As automobiles and airplanes produce "risk of death"; as travel takes up land for roads; as making sheet-steel involves less of other desirable things like leisure, quiet, and rest; as oil wells create an offensive odor in the neighborhood—so all productive activity involves some undesirable by-products.

The Council of Economic Advisers (to the president of the United States) once argued that keeping down the price of cattle could keep down the price of meat to the consumer. The Federal Energy Agency once asserted that holding down crude oil prices reduces the price of gasoline (made from crude oil). Explain why economic analysis rejects these contentions.

Holding down the wholesale price of cattle to the meat processors increases the spread between purchase price and selling price for processors. The price to consumers would rise anyway if there is increased demand for meat. The wealth that would have been available to cattle growers is instead given to the cattle processors. The reasoning is analogous for oil.

Why are costs not measured in terms of labor hours?

Hours of labor have different uses with different values for different quality of labor as well as for different uses of labor. How would you value one labor hour of a skilled surgeon in comparison to one labor hour of a supermarket stocker? Which one would you use as a basis for measuring cost? Hours cannot be used. The best forsaken use value of an hour is the cost of any hour of use of labor.

"Trade between the Mediterranean and the Baltic developed when each area produced a surplus of some good." What do you think this quotation from a history text means? Can you propose an alternative explanation of that trade?

If it is supposed to mean that one area had more of some good than it wanted (could possibly use at all), the statement is wrong. And we can't think of anything else it might mean. We propose that the relative supplies were different, so the relative values (personal worths) were different, leading to mutually preferred exchange and reallocation of goods among Mediterranean and Baltic people.

It is learned that there has been very bad weather in regions that are major coffee growers, so supplies of coffee will be smaller. The result is an almost immediate increase in the price of coffee. Alternatively, it is learned that there are expected to be bumper crops in coffee-growing regions next year, but the current price of coffee does not decline in spite of the expected increase in supply. Explain the asymmetry.

In the case of expected future smaller supply, current stocks of coffee beans can be stored (at some cost) in expectation of even higher prices of coffee in the future. That adjustment causes the current supply for sale to be less than otherwise—hence the higher current price. However, future coffee beans cannot be brought forth for current consumption, so the only effect [273] on current prices will be if current coffee bean holders decide to carry smaller inventories forward and thereby increase current supply for sale. ⚓ ✪

Two refrigerators are available for purchase. One costs more to buy but less to operate: ⚓ ✪ Table 31QA.2 Refrigerators: Purchase Price Annual Operating Cost in Each of 10 Years A $400 $100 B $340 $110 Which is the cheaper source of refrigeration over a ten-year period?

It depends on the interest rate. At 10 percent, the $10 higher operating cost of B for each of 10 years has a present value of $61.50. So machine A, [500] which would avoid that extra cost of $61.50, but costs only $60 more to buy, would barely be cheaper. At 12 percent (or at rates above 11 percent), B would be cheaper. At lower rates A is cheaper. The extent to which it pays to economize on operating costs depends on the rate of interest and the difference in purchase price of the equipment.

The B-17 was a World War II bomber that had a highly coordinated team of specialists, including a pilot, a copilot, a bombardier, a navigator, an engineer/gunner, a radioman, two waist gunners, a ball-turret gunner, and a tail gunner. Which of these ten was most important?

It is a misdirected question: any of them might make the most critical contribution on a given mission. The plane will not leave the ground without the work of the pilots; it may not find the target or return to home base without the navigator; the bombs are not likely to come close to the target without the input of the bombardier; the plane and its crew may not survive the flight or even reach the target if the gunners fail to keep enemy fighters at bay. All on the team must contribute as circumstances require, but it is an empty exercise to try to measure individual productivities, designating one vital contribution as more vital than another vital contribution—the crew live, fight, and sometimes die together, and there is little temptation to shirk at 20,000 feet in enemy territory.

The spread among gasoline prices of Regular, Intermediate, and Premium is larger for full-service than for self-service. For self-service, the difference in prices may range from about 15 to 20 cents; for full service, the spread would be from about 20 to 30 cents. You get the same gasoline whether it's self-service or full service. What makes it more costly for the attendant to fill the gas tank with the premium than filling it with regular?

It is not more costly; the gas station judges that the demand is more inelastic for full service

A television mogul sees potential in an attractive but young, inexperienced, and generally unknown performer. The novice performer is signed to a five-year contract, and is expensively groomed and promoted to be featured in a new TV series. After a couple of successful years, the young star becomes discontented with a salary that seemed initially attractive but now supposedly does not befit a star. A contract is a contract, but might a proponent of free enterprise and the open market agree that the performer is being exploited?

Many investment prospects do not pay off well. Actors are contracted, but do not blossom as glamorous and successful performers; wells are drilled into dry holes; enormous research expenses yield no miracle drugs; books are published and promoted but sell only ten copies; baseball players are cultivated in the minor leagues for years without becoming big leaguers. ⚓ ✪ Potential investors seek some degree of protection against ultimate disappointment, lest the speculative investment not be made. The young [400] performer in the question above was overpaid for a time, but then under-paid, the later underpayment being an offset to the initial high probability of a failed nontrivial investment

"Marginal costs serve as a guide to how much of a good to produce, while average costs help indicate whether to produce the good at all." Explain.

Marginal costs along with marginal revenue indicate maximum wealth output, while average costs in relation to price indicate whether the profits are positive or negative.

If it were illegal to sell automobiles outside the state in which they were made, would cars be cheaper or more expensive in the United States? Give two reasons for your answer.

More expensive since we would lose the gains of a) volume and b) greater specialization.

Why is it nonsense to talk about urgent, critical, crying, vital, basic, minimum, social, or private needs?

No such thing as basic, vital need—except that we "need" more of everything that is not free. It's a matter of what price we are willing to pay and a matter of more or less, not all or none

Suppose that rich people got rich exclusively from profits. Suppose further that those who received the profits were no smarter, no more foresighted, no nicer, no harder working, and no more physically or mentally productive than other people. Does this mean that their profits are "undeserved"? Does it mean that the rich people performed no service?

No. The basic remaining source of their profits is risk-taking—bearing risks others chose not to bear. They perform a selective risk-bearing function, whether they know it or not. In prospecting for oil, some will lose and some may win. If we want more oil, the "lucky" investors who bear the risks relieve us risk-averse sorts of performing that function. For that contribution they are allowed, under private property rights, to obtain profits. As for taxing them away, that depends upon your desire to have risks borne voluntarily, upon your willingness to uphold a general agreement to let lucky ones keep wealth, and upon attitudes toward differences in wealth among people.

"New business firms can underprice older firms, because the newer firms can buy the latest equipment and are not burdened with the older, less economical equipment which older firms must retire before they can economically adopt the new. This is why continued technological progress contributes to maintaining a competitive economic system." Explain the errors in both sentences.

Old firms are not burdened by old equipment. That they don't simply shut down or switch to producing other goods means they can compete by using old equipment, whose value is recapitalized to whatever level will enable it to continue to be used—unless its value drops to zero, in which case it will certainly be retired. The first sentence is typical of a very common error—an error that ignores the market's revaluation process of existing productive resources. What is relevant for production decisions is current market value of equipment and resources, not the historical value or initial purchase price.

What is nonsensical about the proposition, "A good economic system maximizes the welfare of the maximum number of people"?

Only one quantity can be maximized subject to all others being held at specified levels. You can maximize the welfare of one person provided that the welfare of each of the other people is unchanged.

It has been argued that politicians tend to gain from price controls, and hence they advocate them. What line of reasoning would support that argument?

Price-controlled goods are distributed with more political and government influence and authority: government officials set the prices and enforce the program—and take credit for supposedly keeping down the living costs of constituents

The difference (for pricing and output behavior) between price-taker's and price-searcher's markets can be characterized by a difference in the demand curve facing each seller. Describe the difference in the demand curves.

Price-taker's demand curve is horizontal at highest price at which seller can sell any of his product, while in price-searcher's market his demand curve is a negatively sloped function

When a group of Soviet officials touring American farms asked, "Who tells the farmers how much to produce in order to supply the appropriate amounts of goods?" the host farmers said that no one told them. But the Soviet visitors were convinced the American farmers were concealing something. What would you have told the Soviet visitors?

Private property rights plus knowledge of the market prices of various alternative crops make rational individual decision making feasible.

Why are plans to reduce restrictions to foreign trade commonly protested?

Proposals to open a nation's market to producers of just one kind of product provoke intense opposition by the few projected losers. The many projected beneficiaries, though gaining more in total, individually gain too little to induce united dominating pressure for approval. That appears to be a reason why attempts to reduce world trade barriers are often in the form of general agreements covering many commodities and many nations.

Which tactic would be more likely to get you a lower price on a new car: going to just one dealer and acting like a tough and aggressive bargainer or going to several dealers and mildly asking for their selling price while letting it be known that you really intend to buy a car and are shopping around? Explain why.

Shopping several sellers is better because alternatives are what sellers must beat. It's sellers who compete against other sellers, not buyers who compete against sellers.

"Under socialism, cooperation will replace competition." Is the quoted proposition correct? ⚓ ✪ What evidence can you cite to support your answer? What is the difference between cooperation and competition?

Since scarcity is present in socialism, as in capitalism, competition for control of resources is inescapable. In socialism more is in the form of political [14] avenues of competition (persuasion, favors, personal connections). Competition is the interpersonal striving for more of what is scarce and desired—for production, by purchase, by striving for political power, and so on. Cooperation is a joint activity with mutual striving for a common end.

Contrast socialism and private property as means of distributing risks of profits and losses.

Socialism does not permit selective, discretionary optional selection of wealth holdings by each individual. Profits and losses are borne in accord with taxes, rights to use government resources, and powers of political office. In a system of private property with open access to trade, consequences—value change of resources, profits and losses—are borne by the owner. By selectively purchasing and selling goods, people can adjust the combination of risk they bear under private property.

Why are tickets to sporting events typically declared not legally transferable at higher prices at the scene of the event (i.e., no "scalping")? Yet the buyer and the seller would both prefer to be able to do so. Who, if anyone, would lose?

Sometimes tickets are deliberately underpriced—such as those made available to college students by their university—and the administrators [343] don't want the students to buy the cheap tickets solely for the purpose of reselling to nonstudents. At other sporting events, organizers may fear that large blocks of tickets will be purchased by potential scalpers for re-sale (with the embarrassing revelation that the organizers had underpriced their product), and if the tickets are not successfully resold, there will be a lot of empty seats.

Explain or criticize the following statements and questions about the substitution postulate: "Every student substitutes some romance for grades when he dates rather than studies as much as he otherwise could have." "The substitution postulate says that a student does not seek the highest possible grades." Does the substitution postulate deny that water, food, and clothing are more basic or more needed than music, art, and travel? "There is no hierarchy of wants." What does that mean? Can you disprove it? Is travel in Europe a substitute for formal academic education? For some food? For a bigger house or new clothes or medical care? For what would it not be a substitute? ⚓ ✪ "I'd like to play poker with you again tomorrow night, but I don't think my wife would like it." Is this consistent with the substitution principle? Is the wife's utility being compared with the husband's? Explain.

Substitution means there are trade-offs. A person gives up some (not necessarily all) of one good or service for some more of another. This applies to all desired things—goods, services, goals, objectives, ideals, morals. [106] People give up some of one ideal for some more of another ideal. All goals and ideals are competitive and substitutable in degrees of achievement or fulfillment. The emphasis is on more versus less—not on all or nothing.

A filmmaking company once advertised, "The price of a new organic chemical depends on how badly it is wanted—precisely as conceived by classical economic theory, except for reversal of direction. The bigger the demand, the lower the price. A 1,000-pound-per-day process operates more efficiently than a 1,000-pound-per-month process—which is obvious to you but wasn't to Adam Smith. Old Adam set down the rules for our game in ignorance of elementary chemical engineering and advanced advertising." Explain wherein the ad writers for the company are doubly confused—on both the demand and the supply side.

The ad writers have mixed up rate and volume effects on costs. A greater supply—volume—implies a lower unit cost and also a lower price. Bigger volume demand yields lower price because it evokes a greater supply (in volume sense). But in the rate (or speed of production) sense, higher demand yields a higher price. When demand increases in both the volume demanded and the speed at which that volume is demanded, price may fall (in response to volume effect), but it will be higher than otherwise in order to increase the rate of production. What advertising can do is to affect the volume demanded, but if it also increases the rate at which the good is demanded, it leads to higher prices.

"The employer is called the boss because he is able to tell people what to do." Evaluate.

The boss is able to tell people what to do because he pays them. Turning it around, the employee tells the boss what to do—that is, to pay the employee some money. Neither finally tells the other what to do. Each agrees to do something if the other will do something. If it is said, "an employer can fire an employee," so can an employee fire his boss by changing jobs.

Diagnose and evaluate the following news report: "Our city needs more golf courses, according to a report submitted to the City Recreation and Park Department by the National Golf Foundation. The survey discovered that many people do not play as often as they would like because of the lack of courses." Does this differ from the situation of filet mignon, champagne, and autos?

The difference is that price is ignored in determining how many golf courses would be demanded (needed?).

"The time involved in purchasing something cannot be considered part of the cost since the time would have passed anyway. It is an error to count the value of time as part of the cost of any action." Evaluate: What is meant by the value (or cost) of time?

The first statement is true, but the second is false. The value of an hour is the highest-valued use one could have made of that hour. Hence the cost of an act taking an hour is the value of the best alternative action forsaken [43] during that hour. (A common, though not always accurate, measure of the value of time is the earnings one could have obtained during the time.)

An increase in security of property rights in investments will increase the demand for current resources to be invested rather than consumed now. The demand curve will shift to the right and the market rate of interest will be raised. Will the result be a higher pure interest rate or a lower nominal rate with less risk premium?

The interest rate hasn't changed. Instead, we are looking at the nominal rate on a lower-risk class of investments and loans—where the risk premium in the nominal interest rate package is smaller. An increase in the safety and security of property rights can induce more demand for current income to invest for future, safer income. At the same time, increased reliability in the future of rights to the income and property at that time can induce people now to give up more current income rights per dollar of the more reliable future income they will have. Both the demand and supply are larger—shifted to the right. But basically, the pure rate is unchanged. Instead, there is a lower nominal rate—one applicable to lower-risk investments and loans and with lower-risk premiums included in the nominal rate

"If the price of gasoline rose by only 10 percent, many people would not immediately change their consumption." Explain why this does not refute the law of demand.

The law of demand does not say that every person will instantly respond, and respond fully, to every price change no matter how slight. It says a sufficiently high price will induce a response now, and it also says the response will be greater the longer the time allowed. In the case at hand, some people will respond quickly though some will not. Even for a small price rise the aggregate amount demanded over all people will respond because some will respond. In time, all will respond to a sufficiently large price rise.

News item from the past: "Seoul, Korea (AP). The city government ordered the capital's 1500 restaurants not to sell any meal containing rice during lunch hours. The measure is designed to encourage the customers to take other food. South Korea is experiencing a serious food shortage because of a poor rice crop." Would open-market prices achieve the same result? How effective would this measure be?

The poor rice crop is not corrected by the price control. The temporary reduced supply has to be dealt with by curtailing consumption. The curtailment can be accomplished by permitting the market price to rise, thereby conducing to individual decisions which in the aggregate will restrain amount demanded to the amount available.

Explain why the marginal-cost schedule above the lowest average variable cost is the supply schedule of the firm in a price-taker's market? How low a permanent price would make the firm stop production permanently? How low could price be in the short run without the firm suspending production?

The portion of the marginal cost curve above the minimum point on the average variable cost curve is the supply of the price-taker. (Remember the marginal/average relationship.) When price is above the minimum variable cost, but below total per unit cost, the producer is losing money but will continue to produce since he is covering more than the current operating costs. However, when equipment wears out, the producer faces new acquisition and repair costs. He will shut down, since the projected receipts will not cover the new costs.

A Petroleum Crisis? Occasionally, charts are published plotting quantities of so-called demand and supply of something against future time. If the anticipated demand is greater than the supply (perhaps for petroleum), we supposedly will be facing an oil crisis; if supply is greater (maybe for engineers), we are to expect a glut of such specialists. Why are such diagrams fallacious and just plain wrong?

The price is ignored in its effect on amounts demanded and supplied. Past balance or equality reflects the simple fact that the price was allowed to adjust up or down so as to equate amounts demanded with amounts supplied. Any particular forecast path of amount demanded must presume some particular price in each year. A higher projected price would reduce the amount demanded and raise the amount supplied, keeping them equal. An appropriate path of price over the future will affect the amounts demanded and the amounts supplied so as to keep the two equated. Every such projected future imbalance of amounts demanded (probably labeled "needs," "requirements," or "demand") with amounts supplied of any good (probably labeled "supply," "availabilities," or "stocks") is merely a prediction that price will not be allowed to move to equate amounts demanded with amounts supplied.

"In an open market, with buyers and sellers unrestricted in coming to agreements on transactions, the money price of the traded object is the full price: the specified market price is not greater than the personal valuation of the buyer." Right? Or are there nonprice ways in which consumers compete in obtaining commodities? Are there costs to the buyer in addition to the money expenditure directly for the good?

There are exertions, time expenditures, uncertainties and frustrations, and money outlays in buying almost anything—put on your shoes, drive to the store, park and deal with clerks who may be inept, gamble on the quality of products, and pay the babysitter. All this is part of the "full" price.

Why is economic efficiency a more general test than technical efficiency?

There are many alternative ways of doing something, all of which can be technically efficient. But, of these, only one minimizes the value of the forsaken opportunities; that is the economically efficient one. Graphically, every point on the production possibility boundary is productively efficient—but which is economically preferred?

You have a choice of investing in a new issue of twenty-year Treasury bonds yielding 4 percent or a new issue of Venture Corp bonds yielding 7 percent. What would be some reasons for choosing the lower-yielding Treasury bond?

There is no default risk on the Treasury bond, but you might be wiped out if Venture Corp goes into bankruptcy before your bonds mature. Another consideration is liquidity. If you decide you want to sell the bonds before the twenty years are up, you will almost certainly get a higher price for your Treasury bonds than for the bonds of Venture Corp—assuming you can find anyone willing to offer to buy them.

Drug research companies invest heavily in search of drugs or devices for better health. Once success is achieved, the item itself (we'll call it a "pill") can be produced at very low cost, say 1 cent. Any ordinary chemist could then make the pill, at a cost of 1 cent. However, the incentive for research and development would be suppressed if anyone can produce the pill. That's the general rationale for granting patents—"a closed monopoly" right. The pill's price will then appear to be higher than its seeming cost. Suppose ten drug companies each had separately invested in a different research project. One of the projects does succeed. All the other research firms fail. The successful one reaps big revenue, far bigger than its costs. What would you regard as the correct measure of costs of the success? Are the profits excessive for the successful firm, in light of the risks and costs of the ill-fated unsuccessful research? If so, excessive relative to what and for what actions?

There is substantial risk involved in long-term medical research projects. Investors may have to wait years to know whether they have lost everything or stand to make large gains. Any venture capital undertaking also requires significant up-front investment of capital that may be lost if the project is not successful. Competition and unrestricted entry will mean the profits are not "excessive."

A history textbook might tell you that trade in the Mediterranean Sea developed after the Greeks began to produce a surplus of olive oil and found that the Spaniards were producing a surplus of silver. What would economics have to say about the development of trade of olive oil for silver?

There was not a surplus of either olive oil or silver. But the worth of additional amounts of olive oil to the Greeks and silver to the Spanish declined [95] as production increased. Greeks became increasingly willing to trade olive oil for a quantity of silver, while Spaniards became increasingly willing to trade silver for a quantity of olive oil. It became economical to pay for boats and crews to transport the olive oil and silver, while still leaving both the Greek olive growers and Spanish silver miners better off than if trade had not developed.

You are offered the opportunity to purchase a rare painting, and the art dealer says you can be assured that the value of the painting will rise at a 5 percent rate for as long as you care to own it. You call your banker and learn that you could invest long term at a rate of interest of 6 percent. If the painting costs $10,000 today, what will it cost you to own and enjoy the painting for twenty years before you (or your estate) sells the painting?

Use table 30.1. If the art dealer is correct about appreciation of the value of the painting, it can be sold after twenty years for $26,500. If, instead of buying the painting, you had invested the $10,000 at 6 percent for twenty years, you would have $32,000. So the difference, $5,500, is what it will cost you to enjoy the painting.

If the interest rate is 6 percent, would you prefer to have $30,000 available in 10 years or $40,000 in 15 years? Alternatively, suppose the interest rate is 4 percent.

Using table 30.2 (only 2-digit accuracy) at 6 percent, the present value of $30,000 in 10 years: 30,000 × .56 = 16,800; the present value of $40,000 in 15 years: 40,000 × .42 = 16,680. At 4 percent, the present value of $30,000 in 10 years: $30,000 × .68 = $20,400; the present value of $40,000 in 15 years: $40,000 × .555 = $22,400.

Our laws and customs reflect the assignments of risk bearing. Would you advocate that people bear wealth losses to their private property regardless of cause (aside from legal recourse to violators of property rights)? Would you want a homeowner to bear the consequences of a meteorite's falling on his house? From fire caused by careless use of gasoline in the house? Flood damage to houses near rivers? Income loss from cancer? ⚓ ✪ Who should bear the loss if the individual does not?

We cannot outlaw risk. The pains and costs of bad events can be minimized by prudent behavior. But unfortunate things happen, and somehow consequences inevitably are borne by someone. In a community which values and generally relies on a high degree of personal independence and decision making, much of the unhappy consequences of life tend to be borne [360] by the victims. However, individuals can pool resources and share costs in schemes of insurance against more or less predictable misfortunes. And some social and governmental efforts can comfort the weaker members of the community from slings and arrows of outrageous fortune. Usually a distinction is made between misfortunes that result from negligence rather than from "acts of God."

A book was entitled Social Needs and Private Wants. Would the title have suggested something different if it had been Social Wants and Private Needs?

Whatever might be suggested to innocent readers, each title displays sloppy use of analytic language.

"Suppose some firms producing X have unsold output potential that they would like to use to produce more X at current selling prices, if only the market demand were great enough. In this situation, the good X is being sold in a price-searcher's market." Explain why that conclusion can be drawn.

When a price-searcher changes the output rate, that change affects the sales price. To maximize wealth, price-searchers produce at the output rate at which marginal revenue (which is less than price) just covers marginal cost. When the price-searcher has unsold output potential and produces more output, that larger output results in a price decrease so that the additional cost exceeds additional revenue. Profits are lower. In contrast, in a price-taker's market, the producer can sell all the producer wants to sell at the existing price. The price just covers production costs.

"The rent for land in New York City is not a payment necessary to produce the land. It is a necessary payment to obtain use of the land. From the first point of view, it is an economic rent; from the latter point of view, it is a cost." Do you agree?

Yes

Some colleges charge high tuitions, but at the same time they give a large number of tuition fellowships ranging from full tuition payment down to practically nothing. Can you show that tuition grants are a form of discriminatory pricing of education? Does that make them undesirable?

Yes, they are discriminatory. Tuition scholarships lower the price to some students (who would otherwise not be able to attend) without lowering it to all students. Instead of price discrimination, we could call this marginal revenue equalization—since the additional revenue the college collects is not reflected by price (full tuition) for the price-searcher (the college) but by marginal revenue.

You are constructing an apartment building. You can build one with many units and have vacancies sometimes, or you can build a smaller unit and have a no-vacancy sign virtually all the time. If the latter behavior [154] is profitable, can the procedure of having vacancies sometimes be even more profitable?

Yes. It pays to have some vacancies in order to satisfy unpredictable fluctuations in demand rather than instantaneously changing rents and keeping the apartments fully occupied. In maintaining some vacancies, the apartment owner is accommodating renters desiring to be able to move when they want to rather than having to make costly advance preparations, such as matching a departing tenant's move-out date with the incoming tenant's move-in date. Maintaining some vacancies economizes on the high costs of predicting the future and of immediately producing whatever a person wants. Alternatively, we could reduce housing costs by more advance planning of people's activities and by refusing to allow them to change their minds; to do this would reduce housing services and convenience and raise other adjustment costs. And it would reduce liberty.

A distinguished professor of law has said: "Some people believe that every resource which is scarce should be controlled by the market. And since, in their view, all resources except free goods are scarce, all resources—even rights to radiate signals—should be so controlled. But surely some resources are 'scarcer' than others, and thereby possibly merit different treatment. It doesn't advance the argument very much to [170] place a label of 'scarcity' on everything." Do you think economics should be studied by professors of law?

Yes. The problem of economics—scarcity—involves how to determine who gets how much of which goods. What forms of competition are used to resolve these questions? It does advance the argument (analysis?) to grasp the meaning of scarcity and to understand that economics says nothing about which scarce goods ought to be allocated through the exchange-market form of competition and which scarce goods should be allocated by other forms of competition, such as physical force (violence), first come first served, waiting in line, who you know, appearances, personality, personal favors, cultural features. We leave it to you to try to figure out why the "degree of scarcity" should affect the form of competition that should determine how a scarce resource is allocated among alternative uses and users. In any case, scarcity implies competition to resolve who gets how much of which goods. If money competition is suppressed, other forms of competition must occur.

Your investment advisor tells you that if you buy a bond (with a "face" value of $1,000) for $800 with ten years to maturity, you will earn a yield of over 12 percent even though the bond pays only $70 per year. Is the investment advisor correct?

Yes. Your yield to maturity will always be greater than the "coupon" yield ($70 per year for each $1,000 of principal) when you pay a current price that is less than the principal—the "face value" that will be paid to you when the bond matures. In this case, the present value of ten end-of-year payments of $70, plus the present value of $1,000 paid to you at the end of ten years, is more than $800 at 12 percent.

A large lake is stocked with excellent fish, but no one owns the fish or the lake. Only by catching the fish can you acquire ownership in the fish. a. ⚓ ✪ What do you think will be the average age of fish caught as compared to the age of the fish in a privately owned lake? b. Which system—privately owned or "open to the public"—will induce overfishing in the sense that more resources will be devoted to catching fish than the extra fish caught are worth? Why?

a. ⚓ ✪ Fish will be younger and smaller in a lake is not owned or fishing otherwise restricted, for the same reason that apples don't ripen in a public park. No one owns the fish (or trees in a public park), and the only way to capture the value of the fish is to catch them (or to cut the tree and take the wood). No one will have the wealth incentive—or legal power—to save or conserve the fish from those who prematurely catch and take them (or preserve the tree from those who cut it now for lumber). b. When no one owns all fish in the lake, the extra value of the fish taken will be judged by each separate fisherman according to his catch rather than by the total catch in the lake. Absence of property rights in the lake causes competition to acquire property rights in the fish.

You buy a house by borrowing its full price, $80,000. Your annual installments in repaying the loan are $6,400/year for 20 years at 5 percent. (Do you agree? Check with table 31.A1.)

a. $2,400, using $6,400 as your total payments for that year. (Note: this question and the answer assume that interest is compounded only once per year.) b. ⚓ ✪ $4,920. Your payments will continue to be $6,400 per year for the twenty years, but the portion that is interest will decline and the portion that is principal will increase. So, in this second year, interest is 5 percent of the remaining balance ($77,600), or $3,880, so you add $2,520 to your equity. c. $80,000.

Camping fees in almost all state and national parks are so low that people want more space than is available, at certain times of the year. ⚓ ✪ a. Why is the price for camping not at a market-clearing level? b. How much space would people want at a market-clearing price?

a. Camping sites are not privately owned. b. ⚓ ✪ Less space per person.

Heat and light are joint products of an electric light bulb that uses electric power at the rate of 1,000 watts. In one hour the cost of the power is 5 cents. a. ⚓ ✪ How much does the light cost? How much does the heat cost? How much do the light and the heat together cost? b. If you were selling the heat to someone, how much would you charge him? And if, at the same time, you were selling the light to someone else, how much would you charge him?

a. Can tell only that both together cost 5 cents an hour. ⚓ ✪ b. No way to distinguish the buyers with cost data only. With open markets, the price of the package will be competitively lowered to a level where receipts from the joint products are just sufficient to cover the costs of production.

Searching for price: a. How can a price-searcher be searching for a price, when in fact there is available an infinite range of prices—any of which he can charge? b. What happens if he is not good at finding what he is searching for?

a. He is searching for the wealth-maximizing price. b. He is likely to find himself losing money as others enter the business and reduce the price-cost spread.

Suppose a $5 tax is levied on your business—an annual license tax of a flat $5 regardless of how much you produce. ⚓ ✪ a. What will this do to your price and output? b. What does it do to profits?

a. Nothing. While the flat tax doesn't affect current output and price, it does affect profits. If the tax raises total costs (by raising average fixed costs) above marginal revenue, the price-searcher will not reinvest and will go out of business. ⚓ ✪ b. Reduced by $5.

Explain how each of these is a denial of the law of demand and the basic postulates of economics: a. ⚓ ✪ "The budget of the Department of Defense covers only our basic needs and nothing more." b. "Our children need better schools." c. "Nothing is too good when it comes to education." d. "America needs more energy."

a. There is no such thing as a basic need. We could use more security, and we could also get by with less. It's a matter of what price we are willing to pay, and a matter of more or less, not all or none. b. We "need" more of everything that is not free. The amount of any economic good we choose to have is a function of its price. To say our children need more schools ignores what we propose to give up to get more schools. ⚓ ✪ c. It depends upon the price, whether it is good enough to have at that price. If this says simply that more is better than less, OK. Otherwise, it seems to deny relevance of alternatives. d. Same as comment to b.

"It is wrong to profit from someone else's misfortune." a. Explain why, if that were taken literally, we would all be poorer. b. Does the doctor profit from your illness? The farmer from your hunger? The shoemaker from your tender feet? The teacher from your ignorance?

a.all voluntary exchange beliefs for both parties. All voluntary exchange benefits both parties. b. Yes.

"The free-enterprise, capitalist system is free in that it involves no imposition of force or compulsion." Do you agree? Explain your answer.

he capitalist system uses the force of self-interest; it is impersonal in its market effects. The effects of decisions are borne by the owner of a resource. Someone who produces at a loss bears the effect and is forced out of business into some other task, perhaps with less compassion than under a socialist dictator, who might spread the loss to other people instead of concentrating the effect on one person, the owner.

In testing a person's preference between two known options, it has been suggested that if a person agrees to let some unknown party choose for him, then he is indifferent between the two options. Do you think that is consistent with the principles listed in the text?

it is