Deck 3: Demand, Supply, and the Market Process

Question 1

"The future of our industrial strength cannot be left to chance. Somebody has to develop notions about which industries are winners and which are losers." Is this statement by a newspaper columnist true? Who is the "somebody"?

Answer 1

The statement by a newspaper columnist suggesting the existence of a central authority in deciding the status of economic profit and loss of an industry is an incorrect statement.
In a free market economy which, is characterized by the existence of free entry and exit of both firms (producers) and consumers. Moreover, characterized by a well-defined private property right and duly enforced; it is the free forces of market demand and supply and an individual's pursuit of self-interest and opportunity that governs the decision of winners and losers of an industry. There is no place for any central planning authority to decide upon a notion of winning and losing industry. In a free market economy, every individual in search of best possible opportunity and self-interest is guided to take the best possible decision in optimizing profit or utility.
In the given statement, "somebody" refers to the administration or government who is the central planning authority.

Question 2

What factors determine the cost of producing a good or service? Will producers continue to supply a good or service if consumers are unwilling to pay a price sufficient to cover the cost?

Answer 2

Production decision of goods and services are primarily governed by the comparison between the cost of production and the associated market price that is the benefit. Less cost of production and higher market price is an indication for profit incentive and production would increase until profit opportunity exists.
The cost of production of a good depends upon various factors like cost of raw materials, technology of production, unforeseen natural and political disturbances, and government's fiscal policy like taxes and subsidy. Changes in one or all of the above factors can potentially change the cost of production of a good or service.
The factors employed in the production of a commodity have competitive use, as we know that every economy has a resource constraint since there are unlimited wants and limited resources. Thus, there is an opportunity cost of production since a resource needs to be bid away from its other possible uses. If the consumers are unwilling to pay the price sufficient to cover the cost of production then the producer would not continue to supply the good or service and production would fall. If the opportunity cost of production increases than the benefit derived from it that is the market price then the production would fall as it will be an indication of the fact that the resources employed in that good have more valued use in other goods or commodities.
Secondly, it also indicates that there is no incentive for production as there is no scope for profit generation.

Question 3

"Production should be for people and not for profit." Answer the following questions concerning this statement:
a. If production is profitable, are people helped or harmed? Explain.
b. Are people helped more if production results in a loss than if it leads to profit? Is there a conflict between production for people and production for profit?

Answer 3

a)If production is profitable, people are helped. A profitable production implies efficient use of resources and increase in future investment of the commodity. When a production is profitable then it ensures that more firms starts producing the commodity and to increase profit attempt is made to decrease the cost of production by innovating alternate and efficient production process and also inventing substitute products. All these factors altogether lead to decline in the price of the product in the market as supply increase.
b) People are helped more if production leads to profit since profit invites more firms into production and hence results in increase in supply and decease in price.
There is no conflict between production for profit and production for people. Apparently, it may appear that there is no central authority to determine the production need of people. However, market price in a free market economy signals the need and urgency of the goods demanded. When people in a free market economy follows the price signal and work in his or her own self-interest to maximize profit it is the need of the people, which is satisfied at large. Thus, there is no conflict between production for people and production for profit.

Question 4

What must an entrepreneur do to earn a profit? How do the actions of firms earning profits influence the value of resources? What happens to the value of resources when losses are present? If a firm making losses goes out of business, is this bad? Why or why not?

Question 5

What's wrong with this way of thinking? "Economists claim that when the price of something goes up, producers increase the quantity supplied to the market. But last year, the price of oranges was really high and the supply of them was really low. Economists are wrong!"

Question 6

What is the invisible hand principle? Does it indicate that self-interested behavior within markets will result in actions that are beneficial to others? What conditions are necessary for the invisible hand to work well? Why are these conditions important?

Question 7

What's wrong with this way of thinking? "Economists argue that lower prices will result in fewer units being supplied. However, there are exceptions to this rule. For example, in 1972, a very simple 10-digit electronic calculator sold for $120. By 2000, the price of the same type of calculator had declined to less than $5. Yet business firms produced and sold many more calculators in 2000 than they did in 1972. Lower prices did not result in less production or in a decline in the number of calculators supplied."

Question 8

What is the difference between substitutes and complements? Indicate two goods that are substitutes for each other. Indicate two goods that are complements.

Question 9

Do business firms operating in competitive markets have a strong incentive to serve the interest of consumers? Are they motivated by a strong desire to help consumers? Are "good intentions" necessary if individuals are going to engage in actions that are helpful to others? Discuss.

Question 10

Which of the following do you think would lead to an increase in the current demand for beef?
a. higher pork prices
b. higher consumer income
c. higher prices of feed grains used to feed cattle
d. widespread outbreak of mad cow or hoof-and-mouth disease
e. an increase in the price of beef

Question 11

What is being held constant when a demand curve for a specific product (shoes or apples, for example) is constructed? Explain why the demand curve for a product slopes downward to the right.

Question 12

What is the law of supply? How many of the following "goods" do you think conform to the general law of supply? Explain your answer in each case.
a. gasoline
b. cheating on exams
c. political favors from legislators
d. the services of heart specialists
e. children
f. legal divorces

Question 13

Are prices an accurate measure of a good's total value? Are prices an accurate measure of a good's marginal value? What's the difference? Can you think of a good that has high total value but low marginal value? Use this concept to explain why professional wrestlers earn more than nurses, despite the fact that it is virtually certain that nurses create more total value for society than do wrestlers.

Question 14

What is being held constant when the supply curve is constructed for a specific good like pizza or automobiles? Explain why the supply curve for a good slopes upward to the right.

Question 15

Define consumer surplus and producer surplus. What is meant by economic efficiency, and how does it relate to the gains of consumers and producers?

Question 16

How is the market price of a good determined? When the market for a product is in equilibrium, how will consumers value an additional unit compared to the opportunity cost of producing that unit? Why is this important?