Responses to the Discussion Questions of Chapter 5:



Responses to the Discussion Questions of Chapter 6:

Wealthy people seem to have an advantage in discovering and using the new discriminatory rationing criteria that come into play when money prices are not allowed to perform the task of allocating scarce goods. Approximately the same people get the goods. But the suppliers of the goods no longer get the same rewards. That's why deterioration sets in soon after rent controls are imposed. Suppose that a person with a very low income who is paying $400 a month for a rent-controlled apartment in Greenwich Village knows that others are willing to pay $2500 to rent that apartment. Don't you think a deal will be made that will put a wealthier person in that unit while making the current occupant a lot less poor than he was while living there?

(a) $600. You might want to say it's only $100, and that isn't exactly wrong. But it's more useful for many purposes to think of the opportunity forgone ($600) as the cost and the opportunity taken ($500) as the benefit or revenue. $100 then becomes the net loss from renting to you. Economists like to classify consequences into the categories of benefits and costs, which is closely related to the categories of demand and supply. (b) The cost of all these activities will decline. (c) They seem to be thinking of out-of-pocket expenses. But even here they overlook the fact that the demand for resources ultimately determines what these out-of-pocket expenses will be. There are no objective costs that are independent of demand. (d) What other prospective owners are willing to pay for it, which depends on the income they anticipate from ownership, which in turn depends on the rents that tenants are willing to pay. Sometimes apartment owners operating under rent controls have been able to sell their buildings for higher prices because the buyer knew that the rent-control authorities would allow higher rents in order to compensate for the now higher mortgage cost. Notice the circular relationship: the legal rent depends in part upon the mortgage cost which depends upon the purchase price which depends upon the anticipated rent from ownership which depends upon the level of the rents that may legally be charged. (e) The price of fuel will be determined by the demand for it and the opportunity cost of supplying it. You might wonder why this is legitimate in the case of fuel but not in the case of residential housing. (f) We’re not sure why anyone would think that an increased demand for parking can legitimately make parking more costly to obtain whereas an increased demand for rental housing may not legitimately raise the cost of obtaining housing. (Would the commission allow the increase if the landlord owned the parking lot?! See part (c) of question 11 below.)

(a) As long as the city has no intention of replacing the facility, the cost of doing so has no significance for decisions. But the city wanted to raise moorage fees and thought it had to point to some kind of costs to justify its decision. (b) This shows the absurdity of supposing that the cost of creating the facility can be used to determine the cost of renting out moorage space. (c) Every rental denies someone else an opportunity to moor a boat. With a 17-year waiting list, we may assume that a fair number of excluded renters will be people who place a very high monetary value on that opportunity. If the appropriate cost of renting out space is the value of the opportunity forgone, or the price that would be established in a free and open auction, rental rates would probably have to rise considerably to eliminate the queue. The city (in reality, the Seattle Port Authority) probably forgoes a considerable income by not raising rents in the presence of a long waiting list.

It is more efficient to sneak a couple bottles of tequila – or any form of stronger alcohol -- into the dorms rather than beer, because students are much more likely to get caught sneaking in cases or kegs of beer. We are not recommending that students use this as a strategy. Instead, we are using the economic way of thinking to explain the fact that students often do tend to choose the more concentrated form of alcohol, even though they might rather drink beer and wine coolers.

Smaller denomination bills raise the transaction costs for criminals. Before, perhaps a million dollars could fit into a briefcase, when it was made up of $1000 notes. With $500 notes, it would now take two briefcases of money to fulfill a million dollar criminal deal. Not only does this increase transaction costs, but it increases the chances of getting caught. This is why the authorities abolished the $1000 note.

The Godfather was perhaps better at both activities than most others in his criminal family, but he had a comparative advantage in overseeing the “family,” and left it up to others with a comparative advantage in strong-arming and killing others to specialize in those criminal activities.

(a) Suppose a halibut fisherman installed gold fixtures on all the ship's plumbing, or a fancy radar system that didn't work underwater. Would that in any way affect the price the ship's owner could get for the halibut caught? The correct relationship runs the other way. People spend a lot of money equipping halibut boats because they think the expenditures will produce additional halibut that they will be able to sell at a high price. (b) Grocers cannot charge customers more to cover the costs of crime. But high insurance costs do keep grocers from going into or staying in business, fewer stores mean less competition, and less competition can well produce higher prices. (c) Politicians always justified their votes for price supports by pointing to farmers' high costs. But costs will tend to rise over time to match the supported prices, for the simple reason that farmers will want to do more of anything as long as the price they can get for doing it exceeds the cost of doing it, and eventually that must produce higher marginal costs of doing it as resources with ever higher opportunity costs are progressively employed. (d) Assuming that flamingo carving is an instrumental activity and not an activity pursued for its own sake, people carve them because they are valuable. More accurately, they carve them because they expect them to be valuable to others. The history of an object's production will affect its price only in cases where potential demanders value that history. We’re sure the demand for flamingos thought to be carved by a popular and deceased pope would exceed the demand for flamingos with a less inspiring parentage. That's certainly the case with signatures (autographs).

(a) They are able to raise their prices because the hurricane has increased the demand for their services. A glazier (window maker) who tells a caller desperate to have a living room window replaced that he won't be able to get around to it until next week may be asked, "What would I have to pay to get you to come out today sometime?" That sounds like a definite increase in demand. (b) The greatest pressure will come from customers who are not willing to continue with plywood nailed across their broken windows. Some will be in much more of a hurry than others. Maybe they have dinner guests coming tomorrow. (c) The cost to glaziers of repairing windows is the value of the opportunities they thereby forgo. Because glaziers would find some people pleading with them and offering to pay a lot more for prompt service, the monetary opportunity cost to them of repairing windows would rise. In addition, glaziers might find themselves being asked after a hurricane to work 16 or more hours per day. What is the value to a glazier of forgone opportunities to eat, sleep, and relax under such circumstances? Glaziers who raise their rates when the demand for their services increases are not necessarily taking advantage; they may only be placing a reasonable value on their leisure. Notice also that when they choose to work first for the person who offers to pay the highest price, they are (imperfectly) assigning priority to those who place the highest marginal value on window repairs. (d) Glaziers will not want to offend members of the community upon whose patronage they will depend long after the current crisis has been forgotten. They might lose a lot of future business if they raised their prices in a way that people deemed unfair or exploitative. (e) The glazier could call attention to the higher rate for overtime work. Most people think it's fair to charge time and a half or even double time for evening work or work on weekends. (f) Higher prices in the area will not only persuade local glaziers to work longer hours; they will also attract glaziers from other cities not affected by the hurricane.

As people become more interested in buying mandolins, mandolin orders will increase not only at Elderly, but throughout the country. Those retail businesses will therefore increase their orders from the producers themselves. This can put a strain on mandolin manufacturers, such as Gibson. Growing demand will prompt Gibson and other firms to expand output. The higher demand for their instruments at the factory level will allow them to increase output– but they can only do so by bidding up the wages of the skilled mandolin makers. The higher price for their final product will provide them the incentive to bid up the wages of their skilled workers. By the time a mail-order business such as Elderly receives its new stock of mandolins, they will face higher wholesale prices. Elderly will then increase their own prices, because to them it appears that their cost has gone up. Their cost has gone up, but that in itself does not allow them to profitably increase their own prices. Instead, it was the initial increase in demand by consumers that set this whole process in motion. It was the consumers’ growing interest in buying mandolins that generated the competitive bidding process that lead to higher mandolin prices, for which Elderly and other music shops in the country will apologize and state their regret for having to raise prices. But it was the regenerated interest in mandolins by the consumers themselves that lead to the higher prices and costs!

The question asks what advice you would give. We can only guess. We would say that the $15,000 expenditure 40 years ago – her apparent “cost” – is no longer relevant. (Take an even clearer case: supposed she inherited the house for nothing.) The relevant cost is that of maintaining ownership today. What are other similar houses in the neighborhood selling for? The current market value of grandma’s house is not based upon what it cost her to first own the house, but on the current supply and demand conditions in the local real-estate market for similar homes. If similar houses in her neighborhood were now selling for $75,000, we’d advise grandma to ask for a similar price, whether or not she first obtained the house for nothing, for $15,000, or even for $80,000. (Notice how our answer also relates to our answer to question 23 in Chapter 5, where we discuss the issue of historical prices and values.)

(a) It is. The seller is going to include something like a loss of self respect in his estimate of the cost of raising his price on old stock. It will cost him more in self respect to raise the price than he will gain in money by doing so. (b) Even a seller who finds nothing wrong with raising the price on old stock will consider the marginal cost of angering his customers. (c) We can understand it, and understanding is at least a partial defense. We think many people would reason in this fashion: A sum of money paid out makes one poorer, and no one is under a moral obligation to become poorer. A sum of money not received keeps one from becoming wealthier, and people may often be under a moral obligation to refrain from actions that would make them wealthier (at someone else's presumed expense).

(a) Doctors cannot charge more simply because they went to school for many years or because they were unable to secure financial assistance. (b) Unless medical schools accepted and graduated more doctors, this proposal would simply be a subsidy to medical students or, it's important to notice, to medical schools who might thereby be enabled to raise their fees. The author of the Newsweek column was employed by a medical school. (c) Legitimacy does affect moral assessments, and that can be important to any seller who must pay attention to the moral judgments of customers or other providers of funds. Also, if physicians in a particular area were forced to pay protection money, the supply might decrease in that area, so that those remaining could raise their fees and maybe do even better financially under the crime syndicate than they had done before they began paying protection money.

(a) Shortages of health care show themselves when patients must wait in long queues to obtain medical services or when the services are denied altogether or when the patient is compelled to accept a lesser service than the one desired or when the human and physical resources employed to provide the medical services are of a manifestly inferior quality. (b) The answer to part (a) suggests the answer to part (b). Patients will not be given timely appointments and will be told that they must wait 18 months for their surgery. If they die in the interim, that will reduce the length of the queue for others. People over a certain age or who fail to meet specific criteria will be told they are not eligible for certain expensive treatment procedures. Medical services will be supplied by persons who are on average less well trained, less competent, and probably less pleasant to patients. Hospitals will have poorer equipment and more crowded patient facilities. All of these rationing procedures will, of course, reduce the quantity of medical services demanded. This may not be the goal of those charged with the task of rationing scarce medical care services, but it will be the result.

(a) You will eat only four, because a fifth cookie would add nothing but girth to your waist. (b) You will obtain $5 worth of satisfaction: $3 from the first cookie, $1.50 from the second, 40¢ from the third, and 10¢ from the fourth. As you eat more cookies, their marginal value to you declines. But until you are offered a fifth cookie, each additional cookie still adds something to your level of satisfaction. Putting it another way: While you obtained immense pleasure from the first cookie, you still got a little pleasure out of the fourth. (c) The average value to you of the four cookies is $1.25. Contrary to what a lot of people unthinkingly assume, it rarely makes sense to maximize an average. An exception would be a baseball player who wants to maximize his batting average so that he can ask for a higher salary next year. Those who look at averages are looking backward. Economic decision makers look to the future and thus to marginal values. Notice that the baseball player is really looking at next year's salary bargaining. (d) The marginal value of cookies when you stop eating them will depend on the marginal cost to you of eating them. If you have to pay $1 for each cookie, the marginal value of the last cookie eaten will be $1.50. You won't eat the cookie that is worth only 40¢ to you.

(a) At a zero price, people would want to obtain 6 million units of service. If the government pays the entire fee, the price to the patient will be zero whatever fees physicians set. If "fee per service" on the vertical axis refers to fee charged rather than fee paid, the "demand curve" will be completely inelastic (vertical) at 6 million, and the market-clearing price will be $60. The quotation marks above warn that this vertical line is not actually a demand curve, because it does not graph quantity demanded against the price that must be paid. (b) If the fee charged is $30, the fee paid will be $15 and the quantity demanded will be 4.5 million units. If the fee charged is $20, the fee paid will be $10 and the quantity demanded will be 5 million units. Connect these two points with a straight line and it will intersect the supply curve at $40. (c) If the government pays 80 percent, the demand curve will intersect the supply curve at $50. The trick is to derive the demand curve from the fee charged by translating the fee charged into the fee paid, finding the quantity demanded, and then locating the price that will cause that quantity to be supplied.

(a) (i) This will cause a huge increase in the demand for soybeans: the demand curve will shift to the northeast. If the discovery was not anticipated, it would take a great deal of time for suppliers to respond effectively to the higher price that this increase in demand would produce. Supply curves, of course, tend to be much less elastic in the short run than in the long run. An inelastic supply would result in a considerable increase in the price of soybeans. (a) (ii) The opportunity cost of growing corn would rise and hence the supply curve of corn would decrease (shift upward and to the left) as corn land became much more valuable for the growing of soybeans. How much the price of corn would then rise depends on the elasticity of demand for corn. A highly inelastic demand would entail a significant increase in price. (b) (i) Since nylon is a good substitute for cotton, the demand for cotton would fall. In the short run this might produce a large fall in the price of cotton; but if the supply curve of cotton proved elastic in the long run, the price of cotton would gradually rise toward its pre-nylon level. (b) (ii) The cotton gin reduced the cost to buyers of processing cotton into textiles and so increased the demand for raw cotton. (b) (iii) This would increase (lower!) the supply curve of cotton. (b) (iv) Foreign cotton is a good substitute for domestically-grown cotton, so the demand for the latter would fall (shift to the southwest). (c) (i) When deprived of profitable opportunities to litigate, many lawyers will find that the opportunity cost of drawing up wills has decreased. The supply of this service will consequently increase. In the short run, lawyers will just have to live with the decline in profitable litigation opportunities caused by the no-fault law. In the long run, some will choose to leave the business and fewer will choose to enter it, which will make the long-run decline in the price of wills less than the short-run decline. (c) (ii) Moving to another state that doesn't have a no-fault law will be an option for some lawyers, leaving behind fewer lawyers eager to draw up wills. The "long-run effect" will thus be felt more quickly if only one state goes the no-fault route. (d) The impact of the hygienists' efforts will be felt over a long period of time, giving dental floss makers ample opportunity to expand production in response to the slowly growing demand. They will probably be able to obtain the necessary inputs of labor and materials without experiencing any significant rise in marginal costs, which means a very elastic supply curve and hence little increase in the price of dental floss despite the large increase in the demand for it. (e) If the supply of grain is highly elastic, as it seems to be, meat eaters will cause an increase in production rather than a rise in price. In other words, they don't take food from the mouths of the hungry; they cause additional food to be produced. (f) If the increased purchases resulted entirely from an increase in demand, we would expect to see a higher price. How much higher would depend on the elasticity of supply. But an increase in supply, caused perhaps by technical innovations in widget production, would stimulate increased purchases by reducing the price of widgets—a great deal if the demand was very inelastic, very little if the demand was highly elastic. The distinction between quantity changes caused by a shift in demand and changes caused by a shift in supply is fundamental for anyone who wants to use the concepts of supply and demand effectively. Be sure to graph out the analysis of this question so that you can see the argument clearly. (g) An increased demand would probably cause a substantial increase in rental rates because the short-run supply curve of housing is fairly inelastic. In the long-run, as builders and developers respond, the rents would decline toward their previous level. (h) This ordinance increases the cost of renting out space. The shift of the supply curve toward the northwest means higher rental rates and fewer apartment units being rented in the area. (i) This ordinance makes living in the area less attractive for those with cars. The resulting reduction in demand will lower rental rates and cause a decrease in the number of units being rented. (j) It's possible that motorists would respond to the new situation by driving more than twice as much. If so, the demand for gasoline would rise, which would be a perverse result from the standpoint of those who want to compel automobile companies to make vast improvements in the fuel efficiency of new cars in order to reduce gasoline consumption.

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