Markets

Question 1

Markets describe relations between

Answer 1

buyers and sellers – or, what happens when demand curves and supply curves come together.

Question 2

“market outcome” or “market equilibrium =

Answer 2

The price and quantity designated by the intersection of demand and supply curves

Question 3

When prices exceed the equilibrium price, quantity supplied exceeds quantity demanded, resulting in

Answer 3

excess supply of the product.

Question 4

When prices are lower than the equilibrium price, quantity demanded exceeds quantity supplied, resulting in

Answer 4

excess demand for the product. Situations of excess demand or excess supply typically result in price adjustments until market equilibrium is reached.

Question 5

At market equilibrium, consumer surplus + producer surplus (also known as the “total welfare” or “total surplus”) is maximized [explain why]

Answer 5

That is, there is no dead-weight loss, or a loss in value from trades between buyers and sellers that could have occurred but did not.

Question 6

the principle of equity =

Answer 6

Market equilibrium need not ensure an equal or “fair” distribution of surplus between consumers and producers, however, or across consumers or producers.

Question 7

Interventions in markets (by governments or other actors) are often undertaken in an effort to achieve “fairer” outcomes. Common forms of intervention involve ___

Answer 7

price ceilings or price floors.

Question 8

A price ceiling sets ___

Answer 8

a maximum price that can be charged for a product. If the maximum price is above the market outcome, the price ceiling will have no effect. If the ceiling is lower than the market outcome, more consumers will want to purchase the good than producers will want to sell it, resulting in “excess demand” or a shortage.

Question 9

A price floor

Answer 9

sets a minimum price that can be charged for a product (e.g., a minimum wage mandate). Price floors result in excess supply, or surpluses. (In the case of a minimum wage, a surplus would be unemployment).

Question 10

The “cobweb adjustment process” converges to a stable market outcome because:

Answer 10

Demand curves are downward-sloping and supply curves are upward-sloping
If this were not the case, the cobweb process of adjustment will not converge.

Question 11

“cobweb” model of adjustment [explain the dynamic process]

Answer 11

The only stable outcome—where there are no buyers who are willing to pay for the product but can’t get it and no sellers who produce the product but can’t sell it—is the intersection of the demand and supply curves. At that outcome, there is neither excess demand nor excess supply. As a result, there’s no incentive to raise or lower prices further.

Question 12

if there’s excess demand or excess supply at any particular price, there are ___

Answer 12

strong incentives for either buyers or sellers to change their behavior and move the market away from that outcome.

Question 13

When there are shortages in a market, prices typically__

Answer 13

rise

Question 14

When there are surpluses, prices ___

Answer 14

fall

Question 15

where is the total surplus the greatest?

Answer 15

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

Question 16

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

Answer 16

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 17

In the cobweb adjustment story, who or what is coordinating the activities of buyers and sellers?

Answer 17

What’s interesting about this (very stylized) story of market adjustment is that one doesn’t actually need a real person or an organization whose job it is to coordinate buyers and sellers. Instead, 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.

In other words, prices can be thought of as serving a coordinating role for the market.

Question 18

Network effects, scale, regulation, patents, and innovative capabilities are all examples of

Answer 18

factors that slow or even reverse the dynamics of perfect competition. For this reason, they’re often termed “frictions” in markets – since they can slow, or even reverse, the apparent inexorable dynamic of perfect competition.

Question 19

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?

Answer 19

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 20

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

Answer 20

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 21

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 21

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 22

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:

Answer 22

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 23

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?

Answer 23

Quantity will increase and the effect on price cannot be determined.

Question 24

A ski resort 2 hours away from a major city has opened several additional chair lifts and ski runs, and record snowfall this season has led to a great skiing year. What impact does this have on the market for snow tires?

Answer 24

Price and quantity sold will both increase.

Question 25

A new art degree offered this year by a local university has brought many more art aficionados into a city. However, the local art museum’s most famous collection has been loaned to another city for a year. What impact will this have on the market for tickets to the art museum?

Answer 25

Neither the effect on price nor the effect on quantity demanded can be determined.

Question 26

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

Answer 26

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 27

Producer surplus is the difference between

Answer 27

price and the supply curve. Revenue is the price multiplied by the quantity sold.

Question 28

Anti-gouging laws are restrictions or laws ___

Answer 28

(typically enacted by states) against increasing prices in the face of an event. Anti-gouging laws are often motivated by concerns for fairness. For example, one might think: “If a hurricane drives the price of gas way up, only the rich will be able to buy gas. And that’s not fair!”

Question 29

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

Answer 29

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.

Question 30

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

Answer 30

A law setting a minimum wage below the market equilibrium wage.
Setting a price floor below equilibrium will have no impact on the market.

Question 31

Debates over the attractiveness of markets often center around two different objectives: efficiency and equity. [explain]

Answer 31

Markets—and market prices—are often an efficient way of allocating resources. But efficiency may have very little to do with equity or fairness.
On top of that, fairness considerations have a lot to do with personal beliefs: reasonable people can disagree.

Question 32

notion of the “true burden” of a tax is known as

Answer 32

the “economic incidence” of a tax. In the instance above, the incidence of the cigarette tax falls primarily on consumers, not firms.

Question 33

Markets can be created in environments where

Answer 33

they may not previously have existed, by assigning ownership of a good to individuals, or by creating a forum in which individuals can trade. One interesting application of markets is prediction markets, in which buyers and sellers purchase “securities” whose value depends on future events. The probability of these future events occurring can be inferred from the price set on the securities.

Question 34

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

Answer 34

more elastic.
When the supply curve is less steep, or more elastic, firms are more sensitive to the price change caused by the tax, and as a result are able to adjust quantity supplied accordingly. Thus firms will end up “paying” a smaller portion of the tax and consumers will bear more of the incidence of the tax.

Question 35

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

Answer 35

more elastic.

When the demand curve is less steep, or more elastic, consumers are more sensitive to the price change caused by the tax, and as a result are able to adjust quantity demanded accordingly. Thus consumers will end up “paying” a smaller portion of the tax and firms will bear more of the incidence of the tax.