HBX- Economics 4

Question 1

Market Outcome

Answer 1

Refers to the quantity demanded and accompanying price charged for a particular product or service.

(Below is a graph of the supply and demand of lawyers)
the downward sloping blue line is the demand curve, and
the upward sloping red line is the supply curve

Question 2

How many law graduates would firms be willing to hire at a salary of $80,000?

Answer 2

Law firms will be willing to hire 90,000 new graduates.

Question 3

Market Equilibrium

Answer 3

A stable market outcome at which there are no buyers willing to pay for a product that cannot get it (no excess demand) and no sellers who produce a product and cannot sell it (no excess supply); graphically, the market equilibrium occurs at the point where the supply and demand curve for a product or service intersect, denoting the equilibrium price and quantity sold.

Question 4

total surplus to consumers

Answer 4

The difference between consumer willingness to pay and price, added up for all consumers who get to transact in the market.

For example, if the price were $60, then quantity demanded is 40 units and quantity supplied is 60 units, so the amount traded is determined by the demand curve (40 units). And even though every consumer who transacts pays the same price ($60), some end up better off than others—since they had a higher WTP for the product. So a consumer whose willingness to pay was $80 ends up with a surplus of $20.

the gray-shaded upper triangle or trapezoid

Question 5

total surplus to producers

Answer 5

the difference between price and supplier marginal cost (or variable cost), added up for all suppliers who transact in the market. In this case, a firm that was willing to sell the good for $30 can now sell it for $60—and earn $30 in surplus (or profit).

he blue-shaded lower triangle or trapezoid

Question 6

Total Surplus / Total Value Created

Answer 6

the consumer surplus and producer surplus combined.

(the blue and grey area combined)

Question 7

Where is the total surplus the greatest?

Answer 7

It’s when we hit the market outcome—where the demand and supply curves intersect.

Question 8

If a market is not at its equilibrium, and there is excess supply, what is likely to happen to the market over time?

Answer 8

Price will decrease to the point at which quantity supplied is equal to quantity demanded.

Price will return to equilibrium as producers adjust their price and quantity to match demand.

Question 9

At the current price of $1.50 per dozen, producers are willing to produce 1 million pencils, and consumers want to purchase 1.2 million. What will happen to the market for pencils over time?

Answer 9

Producers will raise their prices until the point at which quantity supplied is equal to quantity demanded.

$1.50 is below the equilibrium price for a dozen pencils, and market forces will raise the price until the market is in equilibrium.

Question 10

As we learnt in earlier modules, demand and supply curves are just abstractions: we never really see them. All we see are the _______

Answer 10

market outcomes – the “equilibrium prices,” if you will—but we never really see the trades that didn’t occur.

prices contain information that coordinates—and incentivizes—both sides. For example, if prices are too low, buyers who are willing to pay more than that price will search for (and reach) sellers who are willing to sell to them at a higher price—putting upward pressure on prices. If prices are very high, some sellers will be stuck with goods that no one is willing to purchase—and they’ll reduce prices to attract more buyers.

Question 11

Are short-run indicators good predictors of long-run outcomes?

Answer 11

No. Sustaining performance is hard for firms—even for the most successful ones. And that’s why short-run indicators may not be good predictors of long-run outcomes.

Question 12

What are examples of factors that slow or even reverse the dynamics of perfect competition?

Answer 12

• Network effects,
• scale,
• regulation,
• patents, and
• innovative capabilities

Question 13

Perfect Competition

Answer 13

A market condition in which firms in an industry cannot profit from selling a particular good or service due to the presence of other competitive firms resulting in the market price being equal to the firms’ marginal cost; a perfectly competitive market is characterized by consumer indifference between firms’ products and identical firm cost structures.

• there are profits being made in an industry. More companies enter as a result. They piggyback on the learnings of existing businesses by mimicking either their technology, their business models, or other processes.
• As more and more of such companies enter, their costs look more and more similar to each other. So that what was once the most efficient company, a company that commanded the lowest cost, now finds it hard to sustain that advantage in the face of competition.
• The net result of this dynamic is the following: companies end up looking more or less similar,
• *compete fiercely for customers and have the same costs.** In other words, the supply curve in the long run looks essentially flat. And in that case, no firm makes any profits.

This is what we typically call perfect competition.

Question 14

A recent increase in the frequency of apartment fires has led many landlords to ban the use of candles. What effect will this have on the market for candles?

• Equilibrium price and quantity will both increase.
• Equilibrium price will increase and equilibrium quantity will decrease.
• Equilibrium price will decrease and equilibrium quantity will increase.
• Equilibrium price and quantity will both decrease.

Answer 14

• Equilibrium price and quantity will both increase.
  
  • This would occur as a result of an increase in demand. See correct answer for a more detailed explanation.
• Equilibrium price will increase and equilibrium quantity will decrease.
  
  • This would occur as a result of an decrease in supply. See correct answer for a more detailed explanation.
• Equilibrium price will decrease and equilibrium quantity will increase.
  
  • This would occur as a result of an increase in supply. See correct answer for a more detailed explanation.
• Equilibrium price and quantity will both decrease.
  
  • Since demand for candles has decreased, the market outcome will be at a lower price and quantity than before.

Question 15

A mining company has discovered huge silver deposits in a previously unmined region. What impact will this have on the market for silver?

Answer 15

Price will decrease and quantity will increase.

The new discovery increases the supply of silver, which leads to a higher quantity and a lower price.

Question 16

Manufacturers of a type of cable used to charge electronic devices have improved the production process, reducing their costs. Meanwhile, a popular new e-reader that is compatible with the charger has been released. What is the effect on the market for the chargers?

Answer 16

Quantity increases, and the effect on price cannot be determined.

The new manufacturing process increases the supply of the chargers, but the new e-reader increases the demand. Quantity will certainly increase, but the effect on price will depend on the magnitude of these two changes.

Question 17

Assessing the impact of any “intervention” on a market—a change in technology, the effect of new substitutes or complements, the impact of a policy change, etc.—is a very common and useful exercise.
When you are analyzing the impact of any event or intervention like these on the market equilibrium price and quantity, you want to ask two simple questions….. What are they?

Answer 17

1. Has demand changed? If the event affects consumers’ WTP, the demand curve will shift.
2. Has supply changed? If the event affects suppliers’ costs, the supply curve will shift.

Question 18

• If Supply Increases….
• If Supply Decreases ….
• If Demand Increases….
• If Demand Decreases….

Answer 18

Question 19

If Supply INCREASES (curve shift to the right)

Answer 19

Quantity ↑ Price ↓

Question 20

Supply DECREASES

Answer 20

Quantity ↓ Price ↑

Question 21

Demand INCREASES (curve shift to the right)

Answer 21

Quantity ↑ Price ↑

Question 22

If Demand DECREASES

Answer 22

Quantity ↓ Price ↓

Question 23

Demand AND Supply Increase

Answer 23

Quantity increases, but price is undetermined.

• Manufacturers of a type of cable used to charge electronic devices have improved the production process, reducing their costs. Meanwhile, a popular new e-reader that is compatible with the charger has been released. What is the effect on the market for the chargers?
• A Mexican restaurant in Boston uses tomatillos in many of its dishes, but must pay to ship them from another state where they are grown. The restaurant has recently begun serving a popular green enchiladas dish that uses tomatillos. Meanwhile, fuel prices have decreased. What impact will these changes have on the market for tomatillos in Boston?

Question 24

Supply increase Demand decrease

Answer 24

Price Up and Quanitity ? (Can’t be determined)

Question 25

Demand is up AND down

Answer 25

Neither price nor quantity can be determined.

Question 26

Increased Demand and Decreased Supply

Answer 26

Price goes up, but quantity is undetermined

Question 27

Decreased Demand and Decreased Supply

Answer 27

Quantity will decrease, but price cannot be determined.

Question 29

Consider the market for print encyclopedias. In the last 10 years, the cost of producing encyclopedias has decreased substantially due to lower printing and information acquisition costs. At the same time, more and more people have started using the internet as their primary source of information. What can we infer about the change in the price and quantity in the encyclopedia market over the last 10 years?

Answer 29

With a greater number of alternative sources of information, demand for encyclopedias will decrease. This fall in demand will result in both lower prices and quantity. At the same time, the supply of encyclopedias will increase due to lower costs. This lowers the price and increases quantity. Thus, we can only say for certain that price decreases. The overall change in quantity will be determined by the relative magnitudes of the two effects.

Question 30

Computer prices in the last year have gone down due to technological advancements. At the same time, there has been a large decrease in the supply of new software developers, raising the costs of producing computer software. What will be the impact on the equilibrium price and quantity of computer software?

Answer 30

The price will increase and the impact on quantity cannot be determined.

Computers and computer software are complements. As a result of the fall in computer prices, demand for computer software will increase. The increased demand will cause both prices and quantity to rise. At the same time, the supply of software will fall due to the higher costs. This raises the price of software and causes quantity to fall. Thus we can only say for certain that price increases. The overall change in quantity will be determined by the relative magnitudes of the two shifts.

Question 31

Price Ceiling

Answer 31

A market intervention that sets a maximum price that can be charged for a product or service.

Bruce Springsteen Tickets

Question 32

A price ceiling setting the maximum price of bread below the equilibrium price will result in a:

Answer 32

shortage of bread.

At below-market prices, suppliers will not want to produce as much bread as consumers will want to purchase, leading to a shortage.

Question 33

Answer 33

D is producer surplus, and D+E+F is revenue.

Producer surplus is the difference between price and the supply curve. Revenue is the price multiplied by the quantity sold.

Question 34

Answer 34

A+B

Consumer surplus is the difference between the demand curve and price.

Question 35

Anti-gouging laws

Answer 35

restrictions or laws (typically enacted by states) against increasing prices in the face of an event like Hurricane Sandy.

Question 36

During a severe drought, a country passes a law to keep flour prices low. Which of the following would be the LEAST likely to result from this law?

• Secondary markets will resell flour at higher prices
• New suppliers will bring in additional flour from outside the country
• Long lines will form where flour is being sold.
• Flour will be available to consumers with willingness to pay lower than the “market outcome” or “equilibrium” price.

Answer 36

New suppliers will bring in additional flour from outside the country

• Although suppliers might bring additional flour to the region, the law will actually decrease their motivation to do so.

Question 37

Price Floor

Answer 37

A market intervention that sets a minimum price that can be charged for a product or service.

Example- minimum wage

Question 38

A restaurant typically has a wait time of over one hour before diners can be seated. Which of the following must be true?

• The restaurant serves the customers with the highest willingness to pay for its food.
• The restaurant serves the customers with the lowest willingness to pay for its food.
• The restaurant’s price is below the market equilibrium.

Answer 38

The restaurant’s price is below the market equilibrium.

A long queue implies that there are more customers who want to eat in the restaurant than the restaurant has the capacity to serve, or that there is a shortage of capacity in the restaurant. If the restaurant’s prices were at the market equilibrium for its product, quantity demanded and quantity supplied would be equal.

Question 39

A minimum wage is more likely to increase unemployment if the labor supply is:

• elastic.
• inelastic.

Answer 39

elastic.

• An elastic labor supply would mean employees would want to work many more hours if wages increased slightly. This would make a price floor more likely to lead to a surplus of labor.

inelastic.

• An inelastic supply of labor means that changing wages will not have much effect on the number of hours worked.

Question 40

Under which of the following circumstances would a minimum wage be least likely to lead to unemployment?

• Demand for labor is very elastic
• There is only one employer in the market
• The minimum wage is set above the market equilibrium wage.

Answer 40

• Demand for labor is very elastic
  
  • In this case, a higher wage would lead to a great decrease in quantity of labor demanded, making unemployment likely.
• There is only one employer in the market
  
  • If one firm is the only employer in a market, it may be capable of paying lower wages than its top “willingness to pay,” since there are no other firms competing with it for employees. A minimum wage might increase wages while keeping them below the firms WTP, in which case it might not decrease the quantity of labor demanded.
• The minimum wage is set above the market equilibrium wage.
  
  • A minimum wage above equilibrium would be a “binding” price floor.

Question 41

Which of the following would be least likely to increase unemployment?

• A law setting a minimum wage below the market equilibrium wage.
• A law requiring companies to give all employees 20 vacation days per year.
• A law requiring companies to match employees’ contributions to their 401k plans.

Answer 41

A law setting a minimum wage below the market equilibrium wage.

• Setting a price floor below equilibrium will have no impact on the market.

A law requiring companies to give all employees 20 vacation days per year.

• Companies that did not formerly give this many vacation days would see this law as an added cost of labor, and if wages did not adjust to make up for it, unemployment could result.

A law requiring companies to match employees’ contributions to their 401k plans.

• Companies that did not formerly match 401k contributions would see this law as an added cost of labor, and if wages did not adjust to make up for it, unemployment could result.

Question 42

What factors play a role in determining who captures how much value….?

Answer 42

• Consumers’ “initial endowments” (or, their initial distribution of wealth) matter, as we’ve just seen, since higher incomes usually mean higher willingness to pay, and therefore greater consumer surplus.
• Similarly, a firm’s innovativeness will determine how productive its technology is relative to that of other firms, which in turn affects their relative costs, and therefore their producer surplus.
• On top of that, the allocation mechanism matters: as we saw earlier in this module, pricing and queuing are just two of many different mechanisms for allocating products in an economy, but they have different implications for whether or not there’s excess demand or supply, and for who benefits by how much.
• And last, the slopes of demand and supply curves obviously matter in determining the division of value. A relatively inelastic supply curve implies that small demand shocks will result in large swings in prices for firms. But it also implies that the most efficient firms capture a lot of surplus, while others capture very little. Conversely, a relatively inelastic demand curve will result in large swings in prices with small changes in supply, but will also mean that some high-WTP buyers capture a lot of surplus.

This entire discussion centers around two aspects (or measures) of fairness:

1. first, how is value distributed between the buyers and sellers that participate in the market.
2. Second, there’s the pesky question of those who don’t get to transact at all in the market – those who are way down on the demand curve (like consumer B) or way up on the supply curve (like firm D). Here, again, our notions of fairness matter greatly, and depend on the context. Shutting out inefficient firms—or even consumers who can’t afford concert tickets—is one thing. Shutting out buyers who can’t afford food or health care due to high prices is another.

Question 43

What are several measures of fairness?

Answer 43

• value division between consumers and firms,
• value division across consumers, and
• value division across firms.
• the distinction between labor and capital.

Question 44

Debates over the attractiveness of markets often center around two different objectives: _______ and ______

Answer 44

efficiency and equity.

Markets—and market prices—are often an efficient way of allocating resources. But efficiency may have very little to do with equity or fairness.

Question 45

Which of the following laws would lead to a surplus (quantity supplied more than quantity demanded) of soybeans, if the market price is $14 per bushel?

• A price floor at $10
• A price floor at $20
• A price ceiling at $10
• A price ceiling at $20

Answer 45

A price floor at $10

Setting a price floor below the market price will have no impact on the market.

A price floor at $20

Soybean growers will want to supply more soybeans than consumers will want to purchase, leading to a surplus.

A price ceiling at $10

Consumers would want to purchase more soybeans than soybean farmers would want to grow, leading to a shortage.

A price ceiling at $20

Setting a price ceiling above the market price will have no impact on the market.

Question 46

Which of the following situations is most likely to result in an active resale or secondary market for iPads, if the equilibrium price is $500?

• A price floor at $600
• A price ceiling at $600
• A price floor at $400
• A price ceiling at $400

Answer 46

A price ceiling at $400

• A price ceiling at $400 would lead to excess demand, motivating those who bought the iPads at the low list price to resell them at higher prices.

Question 47

Which of the following laws would result in the greatest consumer surplus + producer surplus?

• A price floor set 10% below the equilibrium price of the product
• A law limiting the quantity produced to a level 5% below equilibrium quantity.
• A price ceiling set 5% below the equilibrium price of the product.

Answer 47

A price floor set 10% below the equilibrium price of the product

• Since this price floor sets a minimum price below the equilibrium, it will have no effect on the market outcome, and will not decrease total surplus.

Question 48

Answer 48

D + E + F is the revenue earned by electricians and C is the deadweight loss.

The revenue electricians earn can be calculated by multiplying the quantity sold by price, which in this case gives the rectangle made by D + E + F. C is the deadweight loss because it represents the surplus (WTP - WTS) from additional transactions that would take place in equilibrium, but do not occur under the price ceiling.

Question 49

A price ceiling is set at 10% below the market equilibrium price. Which of the following must result from the price ceiling? Select all that apply.

Consumer surplus decreases

Producer surplus decreases

Total surplus decreases

Deadweight loss increases

There is no effect because the price ceiling is below the market equilibrium price.

Answer 49

A price ceiling is set at 10% below the market equilibrium price. Which of the following must result from the price ceiling? Select all that apply.

Consumer surplus decreases

Under the price ceiling, fewer consumers will be able to purchase the good than would have bought the good at the equilibrium price, decreasing consumer surplus. However, the consumers that do purchase the good are buying it at a lower price, which increases their own consumer surplus. Thus, total consumer surplus could increase or decrease, depending on the relative size of each effect.

Producer surplus decreases

Under the price ceiling, fewer consumers are purchasing the good and they are each buying it at a lower price. Both effects lower producer surplus.

Total surplus decreases

Total surplus is WTP – WTS for each item sold. Under the price ceiling, the WTP and the WTS are not changing, but the number of items sold has decreased. Thus, total surplus has decreased.

Deadweight loss increases

Deadweight loss is the amount of total surplus that would have been created at the equilibrium price but is not created due to the market intervention. If total surplus decreases, then deadweight loss must increase.

There is no effect because the price ceiling is below the market equilibrium price.

A price ceiling ABOVE the market equilibrium price would have no effect. A price ceiling below the market equilibrium price does have an impact on the market.

Question 50

Dead-weight loss (DWL)

Answer 50

The total lost value of trades that didn’t occur in a market, but would have occurred if the market was at its equilibrium point.

Deadweight loss is the amount of total surplus that would have been created at the equilibrium price but is not created due to the market intervention. If total surplus decreases, then deadweight loss must increase.

Question 51

What are three questions to ask when analyzing the market in terms of supply and demand:

Answer 51

1. What are the sources of supply and demand in this market—who’s buying and who’s selling?
2. What drives the shape (or elasticity) of the supply and demand curves? That is, how sensitive is each side of the market to changes in price and what factors drive this sensitivity?
3. What forces could shift supply and demand in this market?

Question 52

Ultimately, a firm’s willingness to pay for an advertisement is influenced by the advertisement’s impact on sales and profits. And that’s usually driven by what three key metrics??

Answer 52

1. The total number of viewers of the advertisement
2. The share of “relevant” viewers (that is, those who would potentially buy the product). For a firm like Procter & Gamble, relevant viewers might be consumers who are in the market for products like diapers, hair color, laundry detergent, and beauty products. (You can immediately see why the number of “relevant viewers” is so large!). Similarly, for General Motors, relevant viewers are those people looking to purchase a car.
3. The probability that the advertisement convinces the relevant viewer to actually buy the product. This, of course, depends on the effectiveness of the advertisement.

Question 53

When you think about the impact of any change in a market,
any new technology, be sure to consider its impact
on both ____ and _____, not just one side of the market.

Answer 53

demand and supply

Question 54

What is the effect of a $1/pack excise tax on the marginal cost curve for cigarettes?

Answer 54

It increases costs by $1/pack.

If cigarette producers will have to pay a $1 tax on each pack, that effectively increases their costs per pack by $1.

Question 55

Consumers bear more of the incidence of a tax when demand is:

• more elastic
• less elastic

Answer 55

less elastic

When the demand curve is steeper, or more “inelastic,” consumers will bear large price increases, and will end up “paying” a greater portion of the tax.

Question 56

Firms bear more of the incidence of a tax when supply is:

• more elastic
• less elastic

Answer 56

less elastic

When the supply curve is steeper, or more “inelastic,” suppliers will end up “paying” a greater portion of the tax.

Question 57

What determines the true incidence of any tax?

Answer 57

the elasticity of the demand and supply curves!

Question 58

Which of the following firms would want to purchase RMB?

• A company based in China hoping to sell its products to US buyers
• A company based in China hoping to purchase inputs for its products from suppliers in the US
• A company based in the US hoping to sell its products to Chinese buyers
• A company based in the US hoping to purchase inputs for its products from suppliers in China

Answer 58

• A company based in China hoping to sell its products to US buyers
  
  • This company will not need to purchase any currency. The buyers purchasing its products will need to pay in RMB.
• A company based in China hoping to purchase inputs for its products from suppliers in the US
  
  • This company will need USD, not RMB, in order to pay for the inputs.
• A company based in the US hoping to sell its products to Chinese buyers
  
  • This company will not need to purchase any currency. The buyers purchasing its products will need to pay in USD.
• A company based in the US hoping to purchase inputs for its products from suppliers in China
  
  • This company will need RMB in order to pay for the inputs.