Econ 200 Quiz 2

"The law of demand wouldn't hold for diamonds, because if the price of the diamonds fell, they would no longer be a prestige item, and people would therefore buy fewer diamonds." Evaluate

Diamonds are a scarce resource, and the marginal price for a diamond reflects the value the producer and the consumer agree upon for trade. Were prices to decrease, individuals who valued this item would purchase more because of the first and second postulates of consumer behavior. People want more, and they have preferences. People would continue to want more diamonds, and prefer them to other items, therefore, at a lower price demand would increase

Canada and many states in the U.S. have enacted so-called "comparable worth" laws, which require wages paid in occupations legislatures (or the courts) deem comparable to be approximately equal. Consider that in academia, wages differ considerably across fields. Salaries of professors in economics and other social sciences are much higher than salaries in the humanities, such as literature. Do you think economics professors are "comparable" to literature professors? What would the effects be if salaries were equalized between these and all other academic fields?

I do not think that professors of economics and other social sciences are comparable to humanities professors. If salaries were equalized between these and all other academic fields, the number of quality economics professors would decrease since there would be less motivation for them to supply their skills and knowledge at that lower price.

On "Super Sunday," when the Super Bowl is played, some corpulent gentlemen hurl themselves at an ovoid of pigskin. For these exertions, they earn more than post people make in a year, even those who provide a vital service, such as nurses, teachers of economics, etc. Does this mean society values football players more than nurses or teachers?

No, society does not value football players more than nurses. This discrepancy in salaries can be explained by the theory of decreasing marginal value, supply, and by the total value of a service. The total value and total expenditure society has on teachers and nurses is much higher of that of professional football. The reason for the high salaries of football players has to do with the marginal demand for one more player in relation with the total supply of individuals. The total value and expenditure on professional football is quite high, however the supply of players is relatively low, therefore, the marginal cost for one more player is high. The total expenditure on teachers and nurses is much higher than that of football, however there is a greater supply of these individuals, therefore their marginal cost (in the form of salary) is much less than that of a professional football player. This is the diamond water paradox in another guise. These wages reflect only the marginal values of these workers, not their total values to consumers.

The minimum annual salary in major league baseball is greater than the annual earnings of most doctors (and all nurses). Does this mean Americans value baseball players more than doctors?

Same question of the diamond water paradox. The marginal values of additional players is higher than that of doctors and nurses, but the total value and total expenditure of nurses and doctors is much higher. Therefore, no, we do not value baseball players more as a society.

Explain what the "diamond-water" paradox is and how marginal analysis solves it

The diamond-water paradox poses the question as to why a diamond, which is relatively less useful than water, is a more expensive good. The answer has to do with total values, supply, and the marginal cost of an item. Water has a high supply, a high total value, and therefore a low marginal cost. Items that have a low supply, but a high total value will have a high marginal value.

Last year, the United States imported approximately $100 billion worth of oil. Many people believe we should stop importing all oil (about half of our domestic consumption). One argument in favor of this is that this oil is only about 1% of our $10 trillion economy. This, it is argued, it would therefore be a small sacrifice to eliminate entirely our "dependence" on foreign oil, since the economy grows by over $100 billion each year, and therefore eliminating foreign oil would reduce our standard of living only to what it was a year or two ago. No big deal! Evaluate this argument.

The fact that oil is only 1% of our total economy is a representation of marginal values we pay for that oil, not the total value. The money we would be willing to pay as a nation to have all the oil, or none at all, is would be much higher than 1 percent.

"Recently, the price of shoes decreased. Nobody rushed out and bought another pair of shoes. The law of demand obviously doesn't apply to durable goods like shoes." Comment

The law of demand is about rates of consumption. Even though no immediate change may be apparent when price changes, the quantity demanded at the lower price will still be higher.

1.When IBM introduced the first PC in 1982, with 256,000 bytes of RAM and a 5 meg hard drive, it sold for $5,000. Fully loaded top of the line PCs now sell for about $2,500. Has the price of a PC halved in the past twenty or so years? What factors other than the nominal price would you have to consider?

The real price of a PC has more than halved in the past twenty or so years. When looking at inflation and the CPI, 2,500 does not have the same purchasing power as it used to. The drop in relative prices in computers has to do with an increase of good substitutes, and technological advances.

(A Totally Marginal Question) The National Income accounts of the United States add up the "value" of all goods produced in the U.S. economy. The government multiplies the quantity of each (final) good produced by its price and adds all of these numbers together, obtaining what it calls the "total value of all (final) goods produced." [The word final refers to avoiding double counting, by not adding the value of, say, flour to the value of the bread produced by that flour. Ignore this issue in this question.] It turns out that the value thus computed of pet food produced exceeds the value of milk (mostly consumed by children) produced. Does this mean that Americans place greater importance on feeding their pets than feeding their children? Explain.

The total value people would pay to have all milk or none at all would be higher than the total value people would pay to have all the pet food, or none at all. It just so happens that the total expenditure on animal food is greater than the total expenditure on milk.

Many people get paid only once a month. Yet they do not consume their income only on that day; they smooth their consumption over the entire month. Explain why the postulates imply this behavior.

This is an expression of the law of demand, and the 3rd postulate of behavior, decreasing marginal values. The height of the demand curve for present consumption represents the amount of future consumption the individual is willing to trade in order to acquire an additional increment of present consumption. In other words, consumers spend money on items with prices that reflect their willingness to forego future goods and services. Most consumers value future goods and services to the extent that they smooth their consumption to a steady rate over a longer period of time.

The classical economists (Adam Smith and Karl Marx, to name just two) explained the diamond-water paradox by saying that whereas water had high "use value," diamonds had high "exchange value," and diamonds had low "use value." Why is this explanation unsatisfactory, just from the viewpoint of scientific methodology? How does marginal analysis explain the paradox?

This is unsatisfactory because it is an example of ad hoc theorizing. Scientifically speaking, this explanation fails to make a proposition explaining the paradox which could be used to predict and explain other behavior. Marginal analysis explains the paradox by distinguishing the way by which values are decided on items based on supply and total value.

The price of gasoline is almost 4 times what it was a generation ago, and consumers seem to be consuming the same as before, opting for big, performance cars, etc. How can the law of demand be operating.

When we see the rise in prices, this represents a rise in absolute prices. In other words, prices of all of the "general bundle of goods" in the economy have increased. Incomes have increased as well. The real price of gasoline, what compared relatively to other goods, has increased and decreased over time. The trend of big cars and consumption of more gasoline represents the fact that the relative price of gasoline is relatively lower than it was before.

Housing prices have increased in many urban areas. How would you tell if this is an increase in the real (relative) price of houses? Could it be a decrease in real housing prices?

You can tell if it is a real or absolute change price in houses by comparing the change in price relative to other goods in the economy. This is done by comparing the change in price with other goods, and in comparison with the CPI. An increase in the real price means that the house increased in price when compared to other goods. If the absolute prices of all goods in an economy rose, and the prices of urban housing increased, but not by the same amount as the rest of the goods in the economy, this could represent a decrease in real prices.

Suppose some price in the bundle of goods used in computing the CPI increases in price, resulting in a computed increase in the price level of 5%. This calculation, however, assumes consumers keep consuming the same bundle of goods. a. How do consumers respond to this price increase? b.Explain why the calculated increase in the CPI therefore overstates the true impact of this price increase on consumers.

a. If consumer incomes increase by the same amount there will be no change in consumption. If incomes do not increase, we will see a decrease in the general level of consumption of all goods. Consumers mitigate the adverse effect of the price increase by shifting their consumption away from the now relatively more expensive good to a cheaper substitute. b.The calculated price increase overstates the true impact of this price increase on consumers, because incomes tend to rise with an absolute increase in market prices, also known as inflation.