Written Assignment 1

1. What is the mechanism by which the "invisible hand" pushes markets to equilibrium? Adam Smith pioneered the concept of the invisible hand, which allows households and firms to interact and compete with one another. The invisible hand is based on Smiths belief that consumers will always want the best price, and the producers will always want to maximize profit. Basically, if the government would not interfere in what consumers could buy and what producers could produce, and both buyers and sellers were free to make their own choices, then market prices would be beneficial for both consumers and producers (Mankiw 2008). The mechanism of the invisible hand says that producers will try to maximize profits by working more efficiently to maximize production while doing so at the lowest possible price to eliminate competition- in turn other producers will do the same and the consumer is free to choose the lowest priced producer. The push of the invisible hand will result in an increase in financial gain because the consumer is getting a competitive price for high quality goods or services and the seller is increasing sales profits. 2. Explain the two main causes of market failure and give an example of each. The two main causes of market failure are externality and market power. Externality is defined by Markiw, 2008 as: the impact of one persons actions on the well-being of a bystander. An example of externality is traffic congestion. As roads become more and more congested additional roads may need to be built- thus either toll plazas are installed to collect for the project, or higher taxes to pay for additional roads. Also, employers may lose productivity time if their employers get to work late due to the traffic, and also all of the pollution emitted from the congestion, which causes health issues- which is a whole other set of medical costs. Market power is defined by Markiw, 2008 as: the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices. An example of market power that I have experienced first-hand is whenever there is a hurricane in South Florida, and most gas stations run out of gasoline, the sole gas station to still have gasoline will hike up the prices to a ridiculous amount, sometimes even double the price. With no competitors, there is no invisible hand. Local laws to protect citizens during times of emergency include laws now to prevent price gauging but there is no doubt than when a sole gas station doubles their prices because there is no competition that this is complete market power, especially if a small town or area is closed in due to road closures from falling debris; etc.

3. Use a production possibilities frontier to describe efficiency. (This question can be answered either with or without the use of a graph, depending on whether you have a graphing program on your computer. It is possible to describe the various points on the PPF without a graph.)

12

Production possibility curve of Guns and Flowers in the United States

10

Guns Per Million Produced

A
8

D B

0 0 2 4 6 8 10 12 14 16 18 20

Flowers per Million Produced A PPF predicts that all resources are used effectively. This PPF demonstrates how many guns and flowers the United States can produce maximizing all of their resources and technology. Here are the numbers that I used: United States Guns
(In Millions)

Flowers Y 1.0 6.0 10.0

X 18 12 1

As you can see point A, B, and C show at which production rate these goods can be produced more efficiently. Point D shows a production output that is not realistic using the current resources (because it lays outside of the PPF curve) and point E shows an output not utilizing all of the resources available ((because it lays below the production possibility frontier). (I graphed this using Excel, I hope it shows up clearly when I merged it into the Word Document).

4. What is the difference between a positive and a normative statement? Give

an example of each. A Positive statement is fact based and normative statements are opinion based. Positive statement: The unemployment rate in the State of Florida has risen 10% since last year. (Fact) Normative Statement: Miami-Dade County should increase its school funding in every district. (Opinion) The positive statement above can be verified, if need be. Whereas, also my normative statement includes a fact (funding for school districts has decreased over the last 2 years), BUT it is only my OPINION that the county should fun the school districts.
5. Explain how absolute advantage differs from comparative advantage.

Absolute advantage is when a person/country/entity/actor can produce a service or good at a lower price, using fewer resources than their competitor. Comparative advantage is when a person/country/entity/actor can produce a service or good at a lower opportunity cost than their competitor. Absolute advantage is based on actual cost, whereas comparative advantage is based on opportunity cost or how much you give up producing the other. The entity that gives up less has the comparative advantage. Comparative advantage is based on the theory that trading one good you produce at an absolute advantage with one that the entity does NOT produce at an absolute advantage.

6. What are the factors that determine the quantity of a good that buyers

demand? There are several factors that determine the quantity of a good demanded, these include: Price of good--if the prices of a good or service rises people buy less. The quantity demanded of a product is negatively related to its price- as prices rise; the demand

decreases and demand increases when prices decrease. Income--If a persons income decreases then they have less income to spend on goods or services and their demand falls. Expectations--If today you are earning a higher wage than your neighbor, you may be more incline to spend money and thus demand goods/services. But if you think you might be laid-off from work for example, or you just found out your company is closing in the next few months you may be inclined to spend less, decreasing your demand for goods and services. Personal Tastes, as with the example above, even if the price of gold rises very high, but you love gold and you collect it, as an example- you will still buy gold- even at an extraordinary price. This is why economist dont try to explain peoples tastes because there are human psychological factors that play a role outside the scope of study of economics. Number of buyersthe more people desire to buy gold- the higher its demand will be.
7. Define the equilibrium of a market. Describe the forces that move a market

toward its equilibrium. A market equilibrium is when the price of a good or service levels out when the quantity demanded is the same as the quantity supplied. Just like the Frisbee example. If there is a shortage or surplus, then the market is out of equilibrium. The invisible hand or the actions of consumers and producers naturally moves the markets towards equilibrium If there is a shortage, meaning the quantity demanded cannot be fulfilled to the consumer with the quantity supplied prices will rise for the item or good. If there is a surplus, or there is more supply than demand- then the price for the good or service will fall. In the free market that we enjoy in the U.S., when the market is out of equilibrium it is usually only temporary because the supply and demand will eventually even out once again and market equilibrium will be established. 8. List and explain the four determinants of price elasticity of demand, discussed in chapter 5.

1. Availability of substitutes of a good--For example, when candle prices increase from a particular merchant, close substitute candles from another merchant at lower prices causes the higher price candle demand to decrease and the substitute candles, whose prices remained fixed and lower than their competitors to rise. 2. Necessities vs. Luxuries--When the price of baby formula rises, most people will not decrease their demand for it as it is a necessity for babies, but when the prices of gold rise there will be a decrease in demand as this item is considered a luxury by most. Necessities and

luxuries cannot be easily labeled however because they depend solely on the taste of the consumer. Some people may buy more gold when prices rise and choose to make their own baby formula, or switch to a cheaper alternative. 3. Definition of the MarketThe elasticity of demand depends on how the market is viewed. For example, shampoo does not have many substitutes so the demand of that market is very general and for this reason it is usually inelastic. But emergency medical needs is a very narrow market- for example there arent many, if not any substitutes for a dentist visit if your tooth aches, therefore this market is elastic. 4. Time HorizonIf the prices for a good rises, time allows for more substitutes to be made. For example, when prices of cigarettes go up, initially the demand does not decrease, but as smokers find alternatives to smoking cigarettes, such as vapor cigarettes or quitting all together the demand decreases over time.

9.

If demand is elastic how will an increase in price change total revenue? Explain.

According to Makiw (2008) when demand is elastic price and total revenue move in opposite directions. Total revenue can be calculated using P X Q. P is price and Q is quantity. If the price for a pack of gum was $1.50 and the demand was 20 the total revenue is 1.50 X 20= $30.00. With a price increase to $2.00 the demand for gum now falls to 12. The total revenue with the demand is elastic is calculated: 2.00 x 12= $24.00. The loss of revenue is $6.00, even with the price increase. This is because the demand for gum is elastic and the price increase has caused the quantity to drop so much that total revenue now decreases along with the demand, as the loss in demand as offset the increase in price, hoping to create more revenue for the producer.
10. A recent study found that the demand and supply schedules for Frisbees are as

shown in the chart at the following link: Frisbee Chart

What are the equilibrium price and quantity of Frisbees?

Quantity Demanded 1 2 4 Quantity Supplied 15 12 9

Price per Frisbee 11 10 9

8 7 6

6 8 10

6 3 1

The equilibrium price of Frisbees is $8.00 where the demand and supply are equal and the equilibrium quantity is 6 million.

Frisbee manufacturers persuade the government that Frisbee production improves scientists understanding of aerodynamics and thus is important for national security. A concerned Congress votes to impose a price floor $2 above the equilibrium price. What is the new market price? How many Frisbees are sold?

With an increase of $2 to the equilibrium price of $8, the price floor is now $10.00. Because the price floor is over the equilibrium price this new price is binding. At $10, the new demand is only 2 million Frisbees.

Irate college students march on Washington and demand a reduction in the price of Frisbees. An even more concerned Congress votes to repeal the price floor and impose a price ceiling of $1 below the former price floor. What is the new market price? How many Frisbees are sold?

A price ceiling of $1 below the original price floor of $10 would be $9.00- it is over the original equilibrium price of $8.00. Therefore the original $8.00 equilibrium price stays below the ceiling and it is non-binding. And the original demand and supply of 6 million continues to be the same as the market will adjust. References

Mankiw, N. G. (2008). Principals of Macroeconomics (6th ed.). Mason, OH: Cenage Learning.