Chapter 4

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FT1: If the price in a market is above the equilibrium price, does this create a
surplus or a shortage?

A: A surplus: a lot of unsold goods.

FT2: When the price is above the equilibrium price, does greed (in other
words, self-interest) tend to push the price down or does it push it up?

A: Self-interest tends to push the price down: Business owners don’t like
having unsold goods, so they cut the price.

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FT3: Jon is on eBay, bidding for a first edition of the influential Frank Miller
graphic novel Batman: The Dark Knight Returns. In this market, who is Jon
competing with: the seller of the graphic novel or the other bidders?

A: He is competing with other bidders.

FT4: Now, Jon is in Japan, trying to get a job as a full-time translator; he wants
to translate English TV shows into Japanese and vice versa. He notices that
the wage for translators is very low. Who is the “competition” that is pushing
the wage down: Does the competition come from businesses who hire the
translators or from the other translators?

A: Jon is competing with other translators.

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FT5: Jules wants to purchase a Royale with cheese from Vincent. Vincent is willing to offer this
tasty burger for $3. The most Jules is willing to pay for the tasty burger is $8 (after all, his
girlfriend is a vegetarian, so he doesn’t get many opportunities for tasty burgers).

a. How large are the potential gains from trade if Jules and Vincent agree to make this trade? In
other words, what is the sum of producer and consumer surplus if the trade happens?

b. If the trade takes place at $4, how much producer surplus goes to Vincent? How much
consumer surplus goes to Jules?

c. If the trade takes place at $7, how much producer surplus goes to Vincent? How much consumer
surplus goes to Jules?

A: a and b and c. The potential gains from trade are $5 of value ($8 2 $3 5 $5 surplus): It might all
be consumer surplus, it might be producer surplus, or it mightbe some mix of the two. If they
trade at $4, $1 of producer surplus goes to Vincent, and $4 of consumer surplus to Jules. If the
trade happens at $7, Vincent gets $4 of producer surplus, while Jules gets $1 of consumer surplus.
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FT8:
a. When demand increases, what happens to price and quantity in equilibrium?
b. When supply increases, what happens to price and quantity in equilibrium?
c. When supply decreases, what happens to price and quantity in equilibrium?
d. When demand decreases, what happens to price and quantity in equilibrium?

A:
a. When demand increases, price and quantity both rise in equilibrium.
b. When supply increases, price falls and quantity rises in equilibrium.
c. When supply decreases, price rises and quantity falls in equilibrium.
d. When demand decreases, price and quantity both fall in equilibrium.

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PS3: If the price of a one-bedroom apartment in Washington, DC, is
currently $1,000 per month, but the supply and demand curves look as
follows, then is there a shortage or surplus of apartments? What would we
expect to happen to prices? Why?

A: There is a shortage of apartments. We

would expect rents to rise as buyers who are
willing to pay more than $1000 for an
apartment begin to offer higher rents just to
secure an apartment; they’d rather pay more
than not get an apartment at all.

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PS4: Determine the equilibrium quantity and price without drawing a graph.

A: Quantity: 150, Price: $32

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PS5: In the figure below how many pounds of sugar are sellers willing to sell at a price of $20?
How much is demanded at this price? What is the buyer’s willingness to pay when the quantity
is 20 lb? Is this combination of $20 per pound and a quantity of 20 lb an equilibrium? If not,
identify the unexploited gains from trade.

A: At a price of $20 sellers are

willing to supply 20 lb and
buyers are demanding 40 lb.
The buyer’s willingness to pay
at a quantity of 20 is $45 so the
buyers are willing to pay more
than the $20 sellers require to
sell an additional pound of
sugar. Thus, this is not an
equilibrium. Unexploited gains
from trade are shaded.

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PS8: If the price of margarine decreases, what happens to the demand for
butter? What happens to the equilibrium quantity and price for butter?
What would happen if butter and margarine were not substitutes? Use a
supply and demand diagram to support your answer.

A: Price and quantity of butter would

decrease.

If they were not substitutes, there would be

no change in the demand for butter.
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PS9: The market for sugar a. What would happen to the equilibrium quantity
is diagramed below: and price if the wages of sugar cane harvesters
increased?

A: If the wage of sugar cane

harvesters increased, then
the cost of producing sugar
increases, which shifts the
supply curve up/to the left,
thereby increasing price and
decreasing the equilibrium
quantity.

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PS9: The market for sugar b. What if a new study was published that
is diagramed below: emphasized negative health effects of consuming
sugar?

A: If a new study emphasized

the negative health effects of
sugar, then the demand for
sugar would decrease. That
is, the demand curve would
shift down/to the left causing
the equilibrium price and
quantity to decrease.

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PS11: In 2002, the Atkins diet, which emphasized eating more meat and fewer
grains, became very popular. What do you suppose that did to the price and
quantity of bread? Use supply and demand analysis to support your answer.

A: Demand for bread decreases and thus

equilibrium price and quantity decrease.

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C1: For many years it was illegal to color margarine yellow (margarine is
naturally white). In some states, margarine manufacturers were even required
to color margarine pink! Who do you think supported these laws? Why?

A: The dairy industry wanted to prevent margarine from being a good

substitute for butter in order to keep butter prices high. Yellow-colored
margarine is a better substitute for butter than white or pink margarine! Thus,
the dairy industry lobbied for laws to prevent margarine manufacturers from
making their product look more like butter. It is still illegal to sell colored
margarine in Quebec.

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C2: Think about two products, “safe cars” (a heavy car such as a BMW 530xi
with infrared night vision, four-wheel antilock brakes, and electronic stability
control), and “dangerous cars” (a lightweight car such as _____ [name removed
for legal reasons, but you can fill in as you wish]).

a. Are these two products substitutes or complements?

A: They are substitutes.

b. If new research makes it easier to produce safe cars, what happens to the
supply of safe cars? What will happen to the equilibrium price of safe cars?

A: If it becomes easier to produce safe cars, the supply of safe cars will rise. This
will push down the price of safe cars.
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C2: Think about two products, “safe cars” (a heavy car such as a BMW 530xi with infrared night
vision, four-wheel antilock brakes, and electronic stability control), and “dangerous cars” (a
lightweight car such as _____ [name removed for legal reasons, but you can fill in as you wish]).

c. Now that the price of safe cars has changed, how does this impact the demand for dangerous cars?

A: Because the two kinds of cars are substitutes, the fall in the price of safe cars will reduce the
demand for dangerous cars.

d. Now let’s tie all of these links into one simple sentence: “In a free market, as engineers and
scientists discover new ways to makes cars safer, the number of dangerous cars sold will tend to
_______________.”

A: decrease.

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C3: Many clothing stores often have clearance sales at the end of each season.
Using the tools you learned in this chapter can you think of an explanation why?

A: At the end of the season the quantity demanded of some items will be less
than the quantity supplied. To get rid of the excess supply of clothes, producers
will have a sale (reduce the price).

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C4: a. If oil executives read in the newspaper that massive new oil supplies
have been discovered under the Pacific Ocean but will likely only be useful in
10 years, what is likely to happen to the supply of oil today? What is the likely
equilibrium impact on the price and quantity of oil today?

A: The supply of oil is likely to rise today. If oil is going to become cheaper in
the future, then firms are more willing to pump it out of the ground and sell it
today. This will push today’s price down and push today’s quantity of oil up.

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C4: b. If oil executives read in the newspaper that new solar-power
technologies have been discovered but will likely only become useful in 10
years, what is likely to happen to the supply of oil today? What is the likely
equilibrium impact on the price and quantity of oil today?

A: The same thing happens. Oil and solar power are substitutes in many cases
(not in all cases!), so cheap solar energy in the future means that oil will be
less desirable in the future. Time to pump the oil and sell it today while
people are still willing to pay a lot for it!

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C4: c.What’s the short version of the above scenarios? Fill in the blank: If we
learn today about promising future energy sources, today’s price of energy
will _______ and today’s quantity of energy will __________.

A: The answers are “fall” and “rise.” Naturally, the size of the effect depends
on how large and certain future increases are and how easy it is to pump out
more oil in the short run. But the direction of the effect is clear.

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C6: When the crime rate falls in the area around a factory, what probably
happens to wages at that factory?

A: Wages probably fall. There are two ways of thinking about this.

First, if working conditions get better, then the employer can pay lower
wages and still find employees.

Second, and closely related, when working conditions improve, more people
are willing to work in the area and the increased supply pushes wages down.

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C7: Let’s take the idea from the previous question and use it to explain why businesses
sometimes try to make their employees happy. If a business can make the job seem fun (by
offering inexpensive pizza lunches) or at least safe (by nagging the city government to put
police patrols around the factory), what probably happens to the supply of labor? What
happens to the equilibrium wage if a factory or office or laboratory becomes a great place
where people “really want to work?” How does this explain why the hourly wage for the
typical radio or television announcer is only $13 per hour, lower than almost any other job
in the entertainment or broadcasting industry?

A: When jobs become more fun or more safe, more people want to work in those jobs. This
pushes down the wage in those jobs. This means that business owners have a strong
incentive to find inexpensive ways to make their jobs fun, safe, and desirable. This helps
explain why TV and radio announcers earn very little money: Because lots of people want
to be on TV or the radio. People like the attention and the fame.

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 Chapter 2 (Supplement)

C1. In the computers and shirts example from the chapter, the United States
traded one computer to Mexico in exchange for three shirts. This is not just an
arbitrary ratio of shirts to computers, however. Let’s explore the terms of trade a
little bit more.

a. Why is trading away a computer for three shirts a good trade for the United
States? Why is it also a good deal for Mexico?

A: This is a good deal for the United States, because it only gave up one shirt to
produce the computer, so receiving three shirts benefits the United States. It is a
good deal for Mexico because Mexico would have to give up six shirts to
produce one computer on its own, so if Mexico can gain one computer by giving
up only three shirts, this deal makes that country better off.

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 Chapter 2 (Supplement)
C1. In the computers and shirts example from the chapter, the United States
traded one computer to Mexico in exchange for three shirts. This is not just an
arbitrary ratio of shirts to computers, however. Let’s explore the terms of trade a
little bit more.

b. What if instead the agreed upon terms of trade was one computer for eight
shirts—would this trade still benefit both the United States and Mexico?

A: This trade would benefit the United States, which will still be receiving more
shirts (eight) than it gave up in order to produce the computer (one). However,
this would not benefit Mexico because Mexico could have produced its own
computer at an opportunity cost of just six shirts, which would be a better deal
than trading at this rate.
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 Chapter 2 (Supplement)

C1. In the computers and shirts example from the chapter, the United States
traded one computer to Mexico in exchange for three shirts. This is not just an
arbitrary ratio of shirts to computers, however. Let’s explore the terms of trade a
little bit more.

c. What is the maximum (and minimum) number of shirts that a computer can
trade for if the United States and Mexico are both to benefit from the trade?

A: The number of shirts traded for each computer must be higher than one so
that it benefits the United States but less than six so that it benefits Mexico.

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