Economics Exam #2

There are 2 gains from each economic transaction, (1) the price to the seller above her ____________________. (2) The value to the buyer ___________________ above the selling price.

(1) Willingness-to-accept. (2) Willingness-to-pay.

Let's see if the forces of the market can be efficient as a benevolent dictator. Since laptop computers are increasingly easy to build and since they allow people to use their computers whenever they like, an all-wise benevolent dictator would decree that most people buy laptops rather than desktop computers. This is especially true now that laptops are about as powerful as most desktops. In answering questions A-C, answer in words as well as by shifting the appropriate curves in the following figure:

(Refer to imagine from study guide, I don't have plus).

Erin has a choice between two activities: She can repair one transmission per hour or she can repair two fuel injectors per hour. What is the opportunity cost of repairing one transmission?

2 fuel injectors.

Deirdre has a choice between writing one more book this year or five more articles this year. What is the opportunity cost of writing half of a book this year, in terms of articles?

2.5 articles.

Katie works at a customer service center and every hour she has a choice between two activities: answering 200 telephone calls per hour or responding to 400 e-mails per hour. What is the opportunity cost of responding to 400 phone calls?

800 e-mails

If the signaling ability of prices is distorted, then resources are more apt to be ____________________.

Allocated poorly.

The market for economics textbooks is in equilibrium. The government decides to relax export restrictions on paper, leading to an increase in the demand for paper. How does social surplus in the market for textbooks change? Why? Present a figure (diagram) as part of your explanation.

An increase in the demand for paper would also lead to an increase in the price of paper. As the price of paper increases, the cost of producing a textbook will increase. This will shift the supply curve for textbooks to the left. The equilibrium price of a textbook will increase while the equilibrium quantity will fall. Consumer surplus (CS) and social surplus (SS) must fall; it is not clear if producer surplus (PS) will rise or fall.

Why do you think iron and steel became more common around the same time as the increase in price of bronze?

An increase in the price of bronze encourages innovation to produce substitutes.

From price as signal packet (Facts & Tools #1): Suppose you'd like to do five different things, each of which requires exactly 1 orange. Complete the following table, ranking your highest-valued orange-related activity (1) to your lowest-valued activity (5). Give a friend the orange, Throw the orange at a person you don't like, Eat the orange, Squeeze the orange to drink the juice, Use the orange as decorative fruit.

Answers may vary.

Suppose the price per orange is high enough that you buy only four. What activity do you not do?

Answers may vary.

Firms go ____________________, which frees up resources for other uses (labor, materials, etc.).

Bankrupt.

Want a system where it isn't doing something "dumb," (at least we don't want a system where a change (reallocation) to the system could make people ____________________.

Better off without hurting anybody.

Answer to question 6 on Thinking and Problem solving efficiency #2:

Between $50 and $160, you can find both a buyer and a seller who are definitely willing to trade money for a pill. That creates a big incentive for a black market. The price can't be higher than $160 because those demanders might be getting their pills in the price-controlled market. And it can't be below $50 because those suppliers might already be supplying the price-controlled market.

According to reports in the Chinese media, commuters in Beijing are facing a somewhat paradoxical situation: they find it difficult to get a cab while hundreds of cabs lie idle during rush hour. The demand for taxis in Beijing has increased as average incomes have risen. Government-determined gasoline prices have also increased. But the government, worried about rising prices for cab rides, has left the cabs' base fare unchanged. Based on your understanding of how the invisible hand works, what do you think should be done to correct this problem?

Cab fares should be allowed to increase.

Total Social surplus is the combined ____________________ and ____________________ surplus: TS = CS + PS

Consumer, Producer.

Which consumers will buy an electric car when the price is $40,000?

Consumers 1, 3, and 4 are willing to buy an electric car when the price is $40,000.

Calculate consumer surplus, producer surplus, and social surplus when the price is $40,000.

Consumers 1, 3, and 4 are willing to pay a total of $80,000 + $70,000 + $40,000 = $190,000 for three cars. At a price of $40,000 they will pay 3 x $40,000 = $120,000 for those cars. Therefore consumer surplus equals $190,000 - $120,000 = $70,000. It will cost Firms D, A, and C a total of $20,000 + $30,000 + $40,000 = $90,000 to produce those cars. At a price of $40,000 their revenues equal 3 x $40,000 = $120,000 Therefore producer surplus equals $120,000 - $90,000 = $30,000. Social surplus is the sum of consumer and producer surplus. Therefore social surplus equals $70,000 + $30,000 = $100,000.

How is the increasing price of bronze an incentive?

Consumers will save more money by conserving bronze, consumers who switch to substitutes can save money, entrepreneurs can profit by developing new alternatives to bronze, entrepreneurs can profit by developing ways to recycle bronze.

Data can write 12 excellent poems per day or solve 100 difficult physics problems per day. Riker can write one excellent poem per day or solve 0.5 difficult physics problems per day.

Data has the absolute and comparative advantage at solving physics problems.

An industry is necessary for the ____________________ of a country.

Defense.

Changes in either supply or demand could have pushed these prices down. How would demand have needed to change if it had been the cause of the price change? What about supply?

Demand would have needed to decrease. Supply would have needed to increase.

This is not the same as ____________________ on the national level. _____________________ has efficiencies by specializing in something. Comparative Advantages tells us what to specialize in.

Division of labor, Division of labor.

Which firms will produce the car an electric car if the price is $40,000?

Firms A, C & D.

The Canadian government has wage controls for medical doctors. To keep things simple, let's assume that they set one wage for all doctors: $100,000 per year. It takes about 6 years to become a general practitioner or a pediatrician, but it takes about 8 or 9 years to become a specialist like a gynecologist, surgeon, or ophthalmologist. What kind of doctor would you want to become under this system?

From an economic perspective, you would like to become a general practitioner. In general, you would pick an alternative that generates the highest net benefit. In this question, we can think of the net benefit as the salary minus the cost of obtaining the degree/qualification. Since the wage is capped, the salary will be the same for both alternatives. But the cost of becoming a general practitioner is lower as it takes a shorter time. As a result, becoming a practitioner provides a higher net economic benefit, and is the better option.

Note: Surplus is about, "____________________," not about an accounting of how much money is transacting.

Gains from trade.

Create rich connections between markets by conveying important information about the relatively scarcity of goods. ____________________ mean there are opportunities to improve things...

High prices.

From price as signal packet (Facts & Tools #3): In this chapter, we noted that successful economies are more likely to have many failing firms. If a nation's government instead made it impossible for inefficient firms to fail by giving them loans, cash grants, and other bailouts to stay in business, why is that nation likely to be poor? (Hint: Davis and Haltiwanger. 1999. Gross Job Flows, Handbook of Labor Economics found that in the United States, 60 percent of the increase in U.S. manufacturing efficiency was caused by people moving from weak firms to strong firms).

If the most inefficient firms are kept from failing, then many people are spending their days producing less than they would at a more efficient firm. Less production implies that, on average, people will have less to consume.

Firm managers and entrepreneurs are constantly looking for ways to lower costs AS LONG AS they have an ____________________ to improve the process.

Incentive.

Thinking and problem solving #2: Circa 1200 BCE, a decreasing supply of tin due to wars and the breakdown of trade led to a drastic increase in the price of bronze in the Middle East and Greece (tin being necessary for its production). It is around this time that blacksmiths developed iron- and steel-making techniques (as substitutes for bronze). What does the increasing price of bronze signal?

It tells people that bronze is getting harder to find and its higher price will signal consumers to conserve it more or seek substitutes.

Enable societies to mobilize vast amounts of _____________________ toward common ends (Hint: Tai Lopez).

Knowledge.

When there is a tax on the ____________________, so tax the same imported goods (tit for tat).

Like home industry.

Countries should produce (and potentially export) goods and services for which they have the ____________________ and import goods and services for which the opportunity cost is ____________________.

Lowest opportunity costs, higher.

Under perfect competition, the market is at ____________________.

Maximum efficiency.

In 30 minutes, Kana can either make miso soup or she can clean the kitchen. In 15 minutes, Mitchell can make miso soup; it takes Mitchell an hour to clean the kitchen.

Mitchell has the absolute and comparative advantage at making miso soup, Kana has the absolute and comparative advantage at cleaning the kitchen.

Prices reflect the value of its ____________________.

Next highest use.

Countries go against the theory of comparative advantage when they _____________________.

Restrain trade.

It is a measure of amount of ____________________ that firms received that is above the revenue they would have been willing to take.

Revenue.

It has been reported that John Lennon was once asked whether Ringo was the best drummer in the world, and he quipped, "He's not even the best drummer in the Beatles!" (Paul also drummed on some of the White Album.) Assuming that this story is true and that Lennon was correct, explain, using economics, why it could still make sense to have Ringo on drums.

Ringo has a comparative advantage in drumming.

In one hour, Ethan can bake 20 cookies or lay the drywall for two rooms. In one hour, Sienna can bake 100 cookies or lay the drywall for three rooms.

Sienna has the absolute and comparative advantage at baking cookies.

The theory of comparative advantage explains why countries ____________________ in the production of certain goods and services.

Specialize.

After the development of iron, did the supply or demand for bronze shift? Which way did it shift? Why?

The demand for bronze shifted to the left (down) because there was now a good substitute for bronze.

Laptop and desktop computers are substitutes. Now that the price of laptops has changed, what does this do to the demand for desktop computers?

The demand for desktop computers decreases.

In 1980, University of Maryland, Julian Simon bet Stanford entomologist Paul Ehrlich that the price of any five metals of Ehrlich's choosing would fall over 10 years. Ehrlich believed that resources would become scarcer over time as the population grew, while Simon believed that people would find good substitutes, just as earlier people developed iron as a substitute for scarce bronze. The price of all five metals that Ehrlich chose (nickel, tin, tungsten, chromium, and copper) fell over the next 10 years and Simon won the bet. Ehrlich, an honorable man, sent a check in the appropriate amount to Simon. What does the falling price tell us about the relative scarcity of these metals?

The falling price indicates that the metals are less scarce than what they were before.

Compare your answers to those of problem 3.

The point here is that competitive markets lead to efficiency. The market outcome here leads to the maximum social surplus we found in problem 3.

How low would the price of oranges have to fall for you to purchase five oranges? What does the price at which you would just purchase the fifth orange tell us about the value you receive from the fifth-ranked activity?

The price at which the student would just purchase the fifth orange is the value (or just slightly below the value) of the fifth-ranked activity.

Since it's become much easier to build better laptops in recent years, laptop supply has increased. What does this do to the price of laptops?

The price of laptops would decrease.

How does the change in desktop demand affect the quantity supplied of desktop computers?

The supply for desktop computers decreases.

Which consumers should purchase those cars?

The three consumers who value electric cars the highest should own electric cars: Consumers 1, 3, and 4.

Which firms should produce those cars?

The three lowest cost firms should produce: Firms A, C, and D.

Are all efficient outcomes also​ equitable? Explain.

There is really no definitive answer to this question since issues surrounding efficiency and equity are the domain of normative​ economics, where subjective value judgments are made.

Consumer Surplus measures the extent to which a consumer benefits from participating in a ____________________.

Transaction.

The source of social surplus, the ____________________.

Transaction.

Who do you think asked Congress and the president to keep price floors for trucking?

Trucking companies.

President Jimmy Carter didn't just deregulate airline prices. He also deregulated much of the trucking industry, as well. Trucks carry almost all of the consumer goods that you purchase, so almost every time you purchase something, you're paying money to a trucking company. Based on what happened in the airline industry after prices were deregulated, what do you think happened in the trucking industry after deregulation?

Trucking salaries decreased, trucking companies increased.

In successful economies, there are many _____________________ and ____________________ firms.

Unsuccessful, bankrupt.

Suppose we wanted to maximize the difference between consumers' willingness to pay for electric cars and the cost of producing those cars, i.e., we wanted to maximize social surplus. How many electric cars should we produce?

We should produce three cars. The value of the fourth car would be just $20,000 and would cost $60,000 to produce.

How do economic profits and losses allocate resources in an economy?

When an​ industry's goods​ (or services) become less highly valued by​ society, firms in the industry suffer losses and thus become motivated to put their resources to more profitable uses elsewhere. Businesses always seek to improve their profits and in so​ doing, they move resources into the production of goods and services that society values the highest. When an​ industry's goods​ (or services) become more highly valued by​ society, positive economic profits emerge for firms in the​ industry, attracting new firms and their resources to that industry.

Let us continue with the electric car example from problem 3. Suppose the market for electric cars is competitive. Show that the equilibrium price in this market is $40,000.

When the price is $40,000, three consumers (all except 2) are willing to buy an electric car because their willingness to pay is greater than or equal to price. Three firms (all except B) are willing to sell an electric car since their cost is less than or equal to the price. Therefore supply equals demand when the price is $40,000.

Find the maximum social surplus in the electric car market.

Willingness to pay of the consumers = $80,000 + $70,000 + $40,000 = $190,000 Total Cost = $20,000 + $30,000 + $40,000 = $90,000

Once it became easier to build good laptops, did "invisible hand" forces push more of society's resources into making laptop and push resources away from making desktops?

Yes.

Economic profit equals ____________________.

Zero.