Question 1

Recall from the text that weather is a very important determinant for futures prices of orange juice. Using a supply and demand graph, explain why an expectation of bad weather in the future might cause futures prices to rise today.

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Question 2

A market might have a small quantity traded at a high price in one year, and a larger quantity traded at a low price in another year. If one has data on the quantities traded each year in a market, one can compute the average quantity traded over time. Using appropriate demand and supply graphs, explain how speculators act as a sort of "averaging" effect on markets.

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Question 3

Suppose that speculators expect that a war in the Middle East is likely next year, which could cause a significant decrease in the supply of oil.
a. What could the speculators do to profit from their expectation?
b. What would be the possible impact of the war on the oil market without speculation?
c. What would be the possible impact of the war on the oil market with the action taken by the speculators described in part a?
d. How would the action taken by the speculators impact society?

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Question 4

Many times in economic markets we see new firms drive old firms out of business with lower costs and better products. Are these "business failures" also "market failures"? Explain why or why not.

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Question 5

Explain what Adam Smith meant when he said that the market operates as if "an invisible hand" is guiding the process.

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Question 6

Around 1730, Samurai (warriors) in Japan were paid in rice. There were sometimes bad harvests, which, surprisingly, caused the price of rice to fall. Around this time, through the Dojima Rice Exchange in Japan, the Samurai were able to enter into futures contracts in rice. Rice and currency were both acceptable forms of payment in Japan at this time. Discuss a likely reason why the Samurai might have wanted to enter such contracts.

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Question 7

Suppose you have been hired by the Hollywood Stock Exchange to make predictions on how much a movie will make during its first four weekends at the box office. What kind of information would you use to make your forecast?

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Question 8

Explain why price controls may actually end up making consumers worse off in areas that have experienced natural disasters such as hurricanes.

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Question 9

During the 1973-1974 oil crisis, the United States government implemented price controls and other regulations in order to try and keep prices low. Were these policies the best way to lower prices for consumers? What would have happened in the absence of these price controls?

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Question 10

War is expected to break out in the Middle East. Use two separate supply and demand diagrams to illustrate (1) the current price of oil and (2) the future price of oil. Using the same two supply and demand diagrams, show how speculators affect the current price of oil and the future price of oil.

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Question 11

After natural disasters such as hurricanes, the prices of necessity goods such as bottled water, generators, milk, and so forth, in the areas hit by the hurricane tend to increase dramatically. Many consumers and politicians have termed these increases "price gouging," as they insinuate that suppliers are taking advantage of consumers when they are most vulnerable. Governments have even gone so far as to make price gouging illegal, saying in many places that it is illegal to charge any price significantly higher than "pre-hurricane prices." From an economic standpoint, are these laws that prohibit price gouging efficient? What would happen if these laws were repealed and prices were allowed to increase?

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Question 12

A wheat farmer plans to retire at the end of the growing season, or about three months from now, and take up the leisure activity of fishing. The farmer would like to purchase a $20,000 fishing boat from selling his last crop of wheat. It's possible that when the wheat is harvested in three months that its price will be lower than it is today and the farmer would be unable to afford the boat. How can the farmer hedge his risk against a drop in wheat prices?

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Question 13

When Walmart arrives in a small town, many existing mom-and-pop stores go out of business in 6 to 12 months. In terms of economic efficiency, is Walmart's presence good or bad? Is it possible for a smaller store to successfully compete with a national retailer such as Walmart? Explain.

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Question 14

Explain how speculation tends to smooth prices over time and increase welfare. Use the model of demand and supply to illustrate your explanation.

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Question 15

If speculators expect the future price of a commodity to rise, they may decide to use the "buy low, sell high" strategy in which they buy the commodity at a low price today in order that they may sell it later when prices rise. How might their actions actually cause a self-fulfilling prophecy in the short run? Use a demand and supply graph in your answer.

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Question 16

Oil futures prices are a noisy signal of war in the Middle East. Explain whether this statement is true or false.

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Question 17

If gold currently sells for $1,500 per ounce and you believe that the price of gold will increase in the future, explain how you could make money by purchasing a gold future to have 1 ounce of gold delivered to you in 3 months at a price of $1,700.

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Quiz 7: The Price System