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ECO 108 Chapter Notes - Chapter 4: Price Gouging, Economic Surplus, Shortage

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School
Stony Brook University
Department
Economics
Course
ECO 108
Professor
Estefania Maria Cobos

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Document Summary

Price rationing: the process by which the market system allocates goods and services to consumers when quantity demanded exceeds quantity supplied. Adjustment of price is a rationing mechanism. Price will rise when shortages exist until the new equilibrium comes and the market clears: everything goes to the highest bidder. Why we prevent price from rising to equilibrium: price gouging is bad. Income is unfairly distributed: some items are necessary and should be sold at reasonable price. Attempts to bypass price rationing in the market and use different rationing devices are more difficult and are more costly, and very often the attempts distribute the costs and benefits among households in unintended ways. Price ceiling: a maximum price that sellers may charge for a good, usually set by the government. Queuing: waiting in line as a means of distributing goods/services; non-price rationing system. Ration coupons: tickets which entitle individuals to purchase a certain amount of a given product per month.

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Related Questions

_____ 1. Suppose you make silver jewelry. If the price of silver falls, we would expect you to:

a. be willing and able to produce less jewelry than before at each possible price.

b. be willing and able to produce more jewelry than before at each possible price.

c. face greater demand for your jewelry.

d. face a weaker demand for your jewelry.

_____ 2. If suppliers expect the price of their product to fall in the future, then they will:

a. increase supply (supply curve shifts out) now.

b. decrease supply (supply curve shifts in) now.

c. increase supply in the future, but not now.

d. decrease supply in the future, but not now.

_____ 3. Consider the market for portable air conditioners, initially in equilibrium. When a heatwave strikes, the equilibrium price:

a. increases and equilibrium quantity decreases.

b. decreases, and the equilibrium quantity increases.

c. and quantity both increase.

d. and quantity both decrease.

_____ 4. Buyers can buy all they want to buy and sellers can sell all they want to sell at:

a. prices at and above the equilibrium price.

b. prices at and below the equilibrium price.

c. prices above and below the equilibrium price, but not at the equilibrium price.

d. the equilibrium price, but not at prices above or below the equilibrium price.

_____ 5. The law of supply and demand states that:

a. demand and supply curves shift out as time goes by.

b. the price of a goodwill rise in response to excess demand for that good.

c. when the supply curve for good shifts, the demand curve for that good shifts in response.

d. the equilibrium price of goodwill be rising more often than it will be falling.

_____ 6. If Doritos and Cheetos are substitutes, a rise in the price of Cheetos will cause:

a. the equilibrium quantity of Doritos to fall and the price of Doritos to rise.

b. the equilibrium quantity and price of Doritos to rise.

c. the equilibrium quantity and price of Doritos to fall.

d. the equilibrium quantity of Doritos to rise and the price of Doritos to fall.

_____ 7. New production technology is perfected that allows auto manufacturers to build an automobile using half the labor hours formerly needed. As a result:

a. the equilibrium quantity of automobiles increases and the price decreases.

b. the equilibrium quantity and price of automobiles increase.

c. the equilibrium quantity and price of automobiles decreases.

d. there is likely no change in the number of automobiles produced.

_____ 8. The U.S. government announces that it will raise the interest rate on college student loans beginning in January of next year. The immediate market impact is:

a. the demand curve for student loans shifts out.

b. the supply curve for student loans shifts out.

c. we anticipate that more student loans will be completed next year than this year.

d. all of the above are correct.

_____ 9. What curve shift produces a fall in price and increase in quantity exchanged?

a. An inward shift in the demand curve.

b. An inward shift in the supply curve.

c. An outward shift in the supply curve.

d. An outward shift in the demand curve.

_____ 10. We note that fewer motorcycles were sold this year than last and that the price is also lower. What event could have caused this outcome?

a. A technological change that improved the fuel efficiency of motorcycles.

b. A rise in the wages paid to motorcycle manufacturing workers.

c. A motorcycle craze due to the popularity of Sons of Anarchy.

d. Increasing concerns about health impacts from breathing motorcycle exhaust.

_____ 11. The price that results in quantity supplied equaling quantity demanded is the optimal (best) price because it:

a. maximizes the combined welfare of buyers and sellers.

b. maximizes the cost of the seller.

c. minimizes the expenditure of buyers.

d. all of the above are correct.

_____ 12. Consumer surplus is the:

a. quantity of good consumers get without paying anything.

b. amount a consumer pays minus the amount the consumer is willing to pay.

c. amount a consumer is willing to pay minus the amount the consumer pays.

d. value of a good to a consumer.

_____ 13. In a market, the marginal buyer is the one:

a. whose willingness to pay is higher than all other buyers and potential buyers.

b. whose willingness to pay is lower than all other buyers and potential buyers.

c. who is willing to buy exactly one unit of the good.

d. who would be the first to leave the market if the price were any higher.

_____ 14. If a consumer is willing and able to pay $20 for a particular good and if she actually pays $16 for the good, then her consumer surplus is:

a. $4.

b. $16.

c. $20.

d. $36.

_____ 15. Suppose there is an early freeze in California that reduces the size of the orange crop. What happens to consumer surplus in the market for oranges?

a. Consumer surplus increases.

b. Consumer surplus decreases.

c. Consumer surplus is not affected by this change.

d. We would have to know whether the demand for oranges is elastic or inelastic.

_____ 16. Producer surplus is the area on a supply/demand graph:

a. under the supply curve.

b. between the supply and demand curves.

c. below the price line and above the supply curve.

d. under the demand curve and above the price line.

_____ 17. Economists typically measure economic efficiency using:

a. total producer and consumer surplus.

b. profits to firms.

c. the quantity supplied by sellers.

d. the price paid by buyers.

_____ 18. Which of the following statements is correct?

a. Efficiency and equality are both maximized when total surplus is maximized.

b. Efficiency deals with the size of the economic pie; equality with how fairly the pie is sliced.

c. Efficiency is more difficult to evaluate than equality.

d. Equality is judged on positive grounds; efficiency requires normative judgments.

_____ 19. The price elasticity of demand measures how much:

a. quantity demanded a response to changes in price.

b. quantity demanded a response to changes in income.

c. price responds to a change in demand.

d. Both a and c are correct

_____ 20. Goods with many close substitutes tend to have:

a. less elastic demands.

b. more elastic demands.

c. price elasticities of demand that are unit elastic.

d. income elasticities that are negative.

Short Answer Questions:

All of the following questions are based on the data shown here for coffee demand and supply at a fictional Columbus coffee shop called Go-bucks.

Price Quantity Quantity

per Cup Demanded Supplied

$1.60 1,700 1,220

$1.80 1,555 1,300

$2.00 1,400 1,400

$2.20 1,235 1,520

$2.40 1,060 1,660

$2.60 875 1,820

_____ 21. (6 points) Using the mid-point formula, calculate the price elasticity of demand as the price increases from $1.60 to $1.80.

_____ 22. (6 points) Repeat the calculation of the price elasticity of demand, this time for a price increase from $1.80 to $2.00.

_____ 23. (6 points) Repeat the calculation of the price elasticity of demand, this time for a price increase from $2.40 to $2.60.

24. (4 points) Over which price range is demand inelastic? Over which price range is demand elastic? Does this follow the trend noted in class?

_____________________________________________________________________________

_____________________________________________________________________________

_____________________________________________________________________________

_____ 25. (6 points) Turning to the supply side, calculate the price elasticity of supply as the price increases from $2.20 to $2.40.

26. (2 points) How would you describe the price elasticity of supply over this range?

_____________________________________________________________________________

_____________________________________________________________________________

Please circle the right answer. (two points each)

1. If the price of gasoline is $2.0, and the price elasticity of demand is 0.5, how much will a 10 % reduction in the quantity placed on the market increase the price?

a.There will be 22% increase in the price

b.There will be 5% increase in the price

c.There will be 10 % increase in price

d.There will be 20% increase in price

e. None of the above

2.The consumer's budget line

a. indicates the options from which the consumer can choose

b. identifies the optimal basket for the consumer.

c. identifies the tastes of the consumer

d. ranks the baskets of goods in the order the consumer prefers them

e. shows that the consumer prefers more better than less

3. In the long run, a profit-maximizing firm will choose to exit a market when
a. fixed costs exceed sunk costs.
b. average fixed cost is rising.
c. revenue from production is less than total costs.
d. marginal cost exceeds marginal revenue at the current level of production.

4. When a perfectly competitive firm makes a decision to shut down, it is most likely that
a. price is below the minimum of average variable cost.
b. fixed costs exceed variable costs.
c. average fixed costs are rising.
d. marginal cost is above average variable cost.


5. Which of the following will always cause the demand curve for a product to shift to the right?

a. an increase in income whether the good is a compliment or substitute

b. an increase in the price of the compliment

c. an increase in the price of a substitute

d. an increase in technology

e. a decrease in the price of the good


6. Consumers understandably like lower prices, but they should understand there is a great difference between a lower price produced by the government price ceiling and a lower price that comes about through normal market channels, one benefits the consumer, the other may not.

a. This statement is not true, Consumers are benefited when the government lowers the price and the consumers are benefited when businesses lower the price.

b. This is because when the government forces prices down, there is a shortage and reduction in total surplus. Lower prices through markets don't create shortage but they do benefit consumers.

c. this is because the government forces prices down, there is a surplus and reduction in total surplus. Lower prices through markets don't create surpluses but they do benefit consumers

d. This is because when markets force the prices down, there is a shortage and reduction in total surplus. Lower prices through government actions don't create shortages but they do benefit consumers

e. None of the above


7. How does an increase in the price of a variable input affect the AC and the MC curves?

a. MC shifts to the right and AC increases.

b. MC shifts to the left and AC increases

c. MC shifts to the right and AC does not change

d. MC does not change but AC increases

e. none of the above

 

8. Which of the following is a characteristic of a perfectly competitive market?
a. Firms are price setters.
b. There are few sellers in the market.
c. Firms can exit and enter the market freely.
d. All of the above are correct.

9. In a perfectly competitive market, the process of entry or exit ends when
a. firms are operating with excess capacity.
b. firms are making zero economic profit.
c. firms experience decreasing marginal revenue.
d. price is equal to marginal cost.

 

10. The relative price of two goods is shown by:

a. the slope of an indifference curve

b. the slope of the budget line

c. the diminishing marginal rate of substitution

d. the slope of the income-consumption curve

e. none of the above

11. When firms have an incentive to exit a competitive market, their exit will

a. drive down market prices.
b. drive down the profits of existing firms in the market.
c. decrease the number of goods supplied in the market.
d. All of the above are correct.

12. If a perfectly competitive firm currently produces where the price is greater than the marginal cost, it

a. will increase its profits by producing more.
b. will increase its profits by producing less.
c. is making positive economic profits.
d. is making negative economic profits.

 

13. Does a consumer well being vary along a demand curve?

a. Yes. When price increases, consumers move to a lower indifference curve.

b. Yes. When price increases, consumers move to a higher indifference curve.

c. No. When price increases, consumers stay on the same indifference curve.

d. No. When price increases, the higher price has no effect on budget constraints or indifference curves.

e. None of the above

 

14. If a competitive firm sets its output such that marginal revenue, marginal cost, and average total cost are equal, economic profit must be:

a. Negative

b. positive

c. Zero

d. Indeterminate from the given information

15. Which of the following is a characteristic of a perfectly competitive market?


a. Firms are price setters.

b. There are few sellers in the market.
c. Firms can exit and enter the market freely.
d. All of the above are correct.



One of the major problems with the economy is too many economists! Or perhaps too many politicians who think they understand economics. When politicians seek to improve the conditions in the economy they come up with what at first blush appears to be a great idea. Look at all the people who will be helped! It is not seen that is the problem it is unseen. Adam Smith's invisible hand. It is called The Law of Unintended Consequences. A politician sets out, for the best of reasons, to help a group---the homeless as an example---but in the process, far more people are harmed than helped. The results really don't matter you see because they tried but it simply didn't work. It was the politician's fault! After all, they tried to do something and that's what counts, not the results. The results do not matter.

One example was the Urban Renewal Program in the 1970s. In the processes of cleaning up and renewing city centers, SROs (Single room occupancies) were destroyed. These were cheap rooms that could be rented at a minimal price. It allowed very low-income people to have a room and shelter from the elements. But where were these people to go after urban renewal? This was one of the main causes of what has become a homeless problem.

Another example of this is my experience while living in Arkansas and teaching at Arkansas State. Interest rates were rising rapidly making it difficult for low-income families to obtain mortgages and other consumer loans. This was a time when if you had a mortgage at 14% you had a good one. Then Gov. Clinton, again for the best of reasons, asked the legislature to cap the interest rates at 10 percent. This is called Usury Law. The term Usury goes back at least as far as Thomas Aquinas and his book, The Summa Theologica which dates back to about 1244 AD. It was believed that charging interest on a loan was unchristian and downright evil. It was on this theory that Gov. Clinton based his thinking.

Once again the unseen took hold. All money flowed out of Arkansas into the neighboring states where it could earn a higher return. This is a natural consequence of a price ceiling, which this is. This is the maximum price that can be charged for a good or service. In economics and finance, there is a concept known as the Purchasing Power Parity Theory. Money (resources) flow to the market where it gets the greatest return. In finance, it is also known as arbitrage which is also the basis for most of the world trade. Investment flows to the areas with the highest return. In any event, the Usury Law was a disaster! No one could get a loan in the state as the money flowed to the neighboring states where it could earn a higher return. The Gov. called a special session of the legislature and the law was repealed.

This is also one of the differences between Keynesian and Austrian economists---of which I count myself. If we take a Keynesian and an Austrian economist to the shore of a small lake and give each of them a large rock to throw in the water, The Keynesian will throw the rock, watch them splash, and maybe see the wake the rock created. The Austrian will throw the rock, see the splash, watch the wake spread out from the point of impact. He will also see the boat moored on the opposite shore with a hole in the hull at the waterline. He will see the water lap in and the boat sink. The Keynesian never even knew the boat was there. When something is proposed, Austrian economists carry the effects out to their logical conclusion. Keynesian's, to the primary and perhaps secondary results but rarely to the tertiary. Again what happens as a result of their actions is no concern of theirs because it was the attempt that mattered.

One embedded question.

What is the benefit of carrying an idea to its logical conclusion? Or is there any benefit?