Question 1

Central planning usually fails because:

Accepted Answer

Central planning involves a centralized decision-making authority determining how resources will be allocated and how goods and services will be produced and distributed. This approach often fails due to information and incentive problems. Central planners do not have access to all the necessary information about consumer demand, production costs, and available resources, which can lead to inefficient allocation of resources. Additionally, since there is no competition or market pricing mechanism to guide decision-making, there is little incentive for planners to make optimal decisions. As a result, central planning often results in shortages, surpluses, and inefficiencies.

Question 2

An equilibrium price splits the uses of the good into ________ part(s).

Accepted Answer

An equilibrium price splits the uses of the good into two parts: 1) consumer use, as people buy the good for their personal consumption, and 2) producer use, as businesses buy the good as an input for their production processes. This is because at the equilibrium price, the quantity demanded by consumers is exactly equal to the quantity supplied by producers, resulting in a market clearing price.

Question 3

In a free market, the price of a good is equal to the value of the good:

Accepted Answer

In a free market, the price of a good is determined by the demand and supply of the good. The price of a good will be equal to the value of the good in its next highest-valued use because consumers are willing to pay up to the value they place on the good, and producers will produce up to the point where the marginal cost equals the marginal revenue. This ensures that resources are allocated efficiently to the highest-valued uses.

Question 4

Use the following to answer questions:
Figure: Demand Curve 
-(Figure: Demand Curve) Refer to the figure. Which point on the graph represents an unsatisfied want?

Accepted Answer

Point C represents an unsatisfied want because it lies outside the demand curve, indicating a level of demand that cannot be met given the current resources or prices.

Question 5

Use the following to answer questions:
Figure: Demand Curve 
-(Figure: Demand Curve) Refer to the figure. Which point on the graph represents the value of the good in its next highest valued use?

Accepted Answer

Point B represents the value of the good in its next highest valued use because it is where the demand curve intersects with the supply curve, which represents the opportunity cost of using the good for its next best use. At point B, the price is higher than at point A or C, indicating that consumers are willing to pay more for the good because it is being used for a more valuable purpose.

Question 6

In a "successful" market, there will be:

Accepted Answer

A successful market is characterized by both successful and unsuccessful firms, as competition drives innovation and efficiency, leading to a dynamic environment where some firms thrive while others fail.

Question 7

The great economic problem is to:

Accepted Answer

The great economic problem involves efficiently allocating limited resources to meet as many of our unlimited wants as possible, acknowledging the scarcity of resources.

Question 8

Markets have the advantage over central planning as the method of resource allocation because:

Accepted Answer

Markets allow resources to flow to their highest-value uses through the price mechanism, which incentivizes producers to allocate resources where demand is highest. Central planning, on the other hand, relies on predetermined targets and quotas set by authorities who may not have as accurate information about consumer preferences and needs.

Question 9

The market solves the information problem when allocating resources by:

Accepted Answer

Prices in a well-functioning market economy serve as signals that provide information regarding the relative scarcity of resources and the relative value of goods and services. The prices are formed by the interaction of supply and demand forces in the market, based on the information that buyers and sellers have about the availability and desirability of the goods. As a result, prices convey information about the opportunity cost of producing or consuming a good, as well as the preferences and willingness to pay of consumers. Therefore, the market prices provide a summary of the relevant information that is required to allocate resources efficiently among competing uses, without the need for a central authority or a perfect knowledge of every individual's needs and abilities.

Question 10

The central planning approach failed to optimally allocate oil during the 1973-1974 oil crisis because of problems of:

Accepted Answer

The central planning approach failed to optimally allocate oil during the 1973-1974 oil crisis due to problems of information and incentives. The central planners did not have access to accurate information about the supply and demand of oil, and they lacked the proper incentives to allocate resources efficiently. As a result, the allocation of oil was not optimal, which led to shortages and price increases.

Question 11

Suppose resources are directed by means of a central planner who receives information on all the different uses of these resources. Why might sellers have an incentive to not provide truthful information to the central planner?

Accepted Answer

Sellers may overstate the importance of their product to ensure they continue receiving resources, as they might fear losing out if the central planner reallocates resources based on perceived importance.

Question 12

The text states: "The great economic problem is to arrange our limited resources to satisfy as many of our wants as possible." How does a market achieve this goal?

Accepted Answer

In a market, the forces of demand and supply work together to determine the price of goods and services. Prices act as signaling devices by providing information on the scarcity or abundance of a particular good or service. As a result, resources are directed towards the highest-value uses, enabling the economy to achieve the goal of satisfying as many wants as possible with limited resources. Choice A is incorrect because central planning does not allow for the decentralized decision-making necessary to allocate resources efficiently. Choice C is incorrect because even in a market economy, prices will vary due to differences in supply and demand across different markets. Choice D is incorrect because resource-based futures contracts are a financial instrument that allows for the hedging of risk associated with price fluctuations, but they do not directly help in the efficient allocation of resources.

Question 13

Which statement explains why many economists have often compared the functioning of worldwide markets to the functioning of a computer?

Accepted Answer

Worldwide markets use the price signal mechanism to allocate resources efficiently, which can be compared to how a computer solves large problems by breaking them down into small steps. Therefore, option D is the correct choice. Option A is incorrect because markets do not allocate resources randomly. Option B is incorrect because markets existed long before computers and solved the information problem through various means such as prices, competition, and supply and demand. Option C is incorrect because the allocation problem is solved by the price mechanism, not computers.

Question 14

Suppose that war in the Middle East reduces the supply of oil, forcing the country to economize on oil. How would a central planner optimize the economic problem under this situation?

Accepted Answer

If war in the Middle East reduces the supply of oil, a central planner would optimize the economic problem by shifting oil out of uses for which good substitutes for oil exist. This is because using oil for production processes that have good substitutes for oil would not be efficient and would lead to unnecessary waste of the scarce resource. By reallocating oil to uses that do not have good substitutes, the country can maximize the benefit derived from the limited amount of oil available.

Question 15

Central planning of resource allocation:

Accepted Answer

Central planning of resource allocation was the dominant economic planning method used in both the former Soviet Union and China. While it can succeed in allocating resources, it has been shown to be less efficient than market-based systems, and is often criticized for lacking flexibility and responsiveness to changing conditions. The United States did not attempt central planning during the 2007-2009 financial crisis, but instead implemented policies to stabilize financial markets and increase liquidity. Central planning does not necessarily insure that all resources are used appropriately, as it depends on the effectiveness and accuracy of the central planners' decisions.

Question 16

Use the following to answer questions:
Figure: Demand Curve 
-(Figure: Demand Curve) Refer to the figure. Which part of the demand curve represents the satisfied wants?

Accepted Answer

Segment AB represents the satisfied wants because it shows the amount of goods or services that consumers are willing and able to buy at each price. At the lower prices in segment AB, all consumers who want to buy are able to do so, hence their wants are satisfied. As the price increases and we move along the demand curve to segment BC, the quantity demanded decreases and some consumers who want to buy at the higher price are unable to do so, hence their wants are not satisfied. Point B represents the maximum price that consumers are willing to pay for a particular quantity of a good or service.

Question 17

When the price of oil rises, consumers economize by buying ________ and by ________.

Accepted Answer

When the price of oil rises, consumers are likely to buy less oil because it becomes more expensive. They will also try to find substitutes for oil, such as using public transportation or buying electric cars. Recycling and buying more oil are not logical responses to a price increase.

Question 18

In a demand-and-supply diagram, the market price represents the value of the:

Accepted Answer

The market price represents the value of the good in its next-highest use. This is because as the demand for a good increases, its price also increases until the point where the next-highest use of the good becomes more valuable than the current use. At this point, some consumers switch to alternative goods, and the price of the original good levels off at the value of its next-highest use. Therefore, the market price reflects the value of the good in its best alternative use.

Question 19

Large-scale central planning has been abandoned throughout the world (except for North Korea and Cuba) because of ______ and ___ problems.

Accepted Answer

Large-scale central planning was abandoned due to information and incentive problems. Information problems arise when central planners lack accurate knowledge of individuals' needs, preferences, and productivity. Incentive problems arise because central planners lack the profit motive that drives individuals to work hard and innovate. This often results in inefficiencies, waste, and shortages.

Question 20

The market solves the incentive problem when allocating resources because the:

Accepted Answer

In a market system, consumers are willing to pay for a good or service only if they believe that the value they will receive from using it is greater than the price they must pay. This creates an incentive for suppliers to produce goods and services that meet the needs and wants of consumers and allocate resources efficiently. Therefore, option B correctly explains the role of the market in solving the incentive problem by ensuring that resources are allocated to produce goods that have a demand in the market.

Quiz 7: The Price System