# The Invisible Hand: How Markets WorkProblems, Exercises, Essays and Discussion Questions

### EXERCISES AND PROBLEMS

1. Construct your personal demand curve for gasoline. Ask yourself how many gallons per day you would buy at 50 cents a gallon, one dollar, three dollars, and four dollars. Draw the results as a demand curve.

2. Construct a demand curve for CDs. Ask two of your classmates to write down how many he or she would buy this year at a price of 10 cents per CD, \$5, \$8, \$10, \$12, \$40, \$150). Then add up the quantities demanded at each price.

3. Construct your own supply curve for babysitting. That is, write down how many nights per month you'd be willing to babysit is you were paid \$1 an hour, \$5 an hour, \$10 an hour, or \$20 an hour.

4. You inherit \$100,000,000 from a rich uncle (even though you have regularly criticized him for his crackpot economic theories). What happens to your supply of babysitting labor? Show the change in a diagram with a supply curve. What happens to your demand curve for gasoline? Show the change using a "gasoline market" graph.

5. Paul: My father's company is in trouble. He produces auto parts, and auto manufacturers are cutting back their purchases from him.

Maria: Why?

Paul: Because people are buying fewer cars these days, and that brings down the supply.

Paul's language is imprecise. Correct it. (Hint: Use a demand/supply graph to show him the difference between a movement along the supply curve and a shift of the supply curve.)

6. Michael Jordan did everything on the basketball court better than anyone else. According to the principle of comparative advantage, all the other members of his team should stay on the bench. True or false?

7. Suppose the price of crude oil goes up. How will this affect the gasoline market?

A. Describe in detail how the gasoline market will move toward a new equilibrium.

B. Does this movement toward equilibrium (adjusting to the increased price of crude oil) represent "unintended cooperation among buyers and sellers"? Explain.

8. Processing crude oil into gasoline and plastic yields a by-product of tar, which is used in road building and roof mending. If the demand curve for gasoline shifts outward (demand goes up), what will happen to the price of tar? Will it rise in sympathy? Or does it fall, because now the gasoline bears more of the burden of paying for the crude oil?

9. In Figure 3.2, how much gasoline is demanded at \$3.20? At \$5.10? How much is supplied at \$3.20? At \$5.10? Who is likely to be frustrated in each case (i.e., unable to buy or sell as much as they would like at the current price)?

10. Suppose the price of cell phones suddenly falls.

A. Is it possible that this drop in price could've been caused by a change in the demand for cell phones? Use a graph to explain your answer.

B. Alternatively, is it possible that this drop in price could've been caused by a change in the supply of cell phones? Use a graph to explain.

11. What will happen in the U.S. market for breakfast cereal if

A. the price of cardboard falls?

B. mad cow disease hits the U.S., sadly killing over half of the nation's dairy cows?

C. the U.S. government introduces a new "safe cereal" law, requiring cereal companies to double-check each box of cereal for possible product safety violations?

12. How would the computer market be affected by a technological breakthrough that reduces the cost of producing computers? How would this "technological breakthrough" affect the equilibrium price and quantity of computer programs ("software")?

13. Over the next ten years, the market for flat-screen TVs is expected to experience two major changes: (1) the manufacturing methods used to produce them are expected to become more efficient; and (2) consumers' preference for them is expected to grow. What will be the combined effect of these two changes on the equilibrium price and quantity of "flat-screen TVs"? [Note: There are two possible answers, depending on the sizes of the two changes. Draw two graphs to show this: one where you make the supply shift larger than the demand shift, and one where you make the demand shift larger than the supply shift.]

14. After the terrorist attacks of September 11, 2001, U.S. airlines were required to adopt new security procedures to double-check each plane before takeoff. At the same time, many potential buyers of air travel - frightened by the possibility of future attacks - became less willing to fly. Draw a demand/supply graph (or two) to explain the combined effect of these two changes on the U.S. air travel market.

### ESSAY AND DISCUSSION QUESTIONS

15. A conversation overheard last night at the library . . .

Student #1: I don't get the 'shortage' and 'surplus' stuff. I mean, if I'm a seller and there's excess supply in my market, how would I even know?

Student #2: Economists keep track of what's happening in every market. If they see an excess supply somewhere, they contact the suppliers and ask them to reduce their supplies or lower their prices to help re-balance the market.

Student #1: Are you serious? Is that how it works?

Answer yes or no to student #1's question ("Is that how it works?"), then briefly explain your answer.

16. Identify the features of a market, as mentioned in the text, for the markets in the following commodities:

A. hospital care

B. friends

C. information on business opportunities

D. the stealth bomber (a weapon for national defense)

17. Maria: "You can push the market analogy too far. I have trouble, for example, thinking of a market for babies who are put up for adoption. The idea that we would market babies is offensive to me."

A. What do you think of the trouble Maria is having? Provide your argument.

B. How do you think someone like Bayla (who believes in markets) would respond? Are babies for adoption scarce? How then should they be allocated? Is it good for the babies not to be adopted? Are high payers likely to be loving parents?

18. Bayla: "If we would just allow the invisible hand to work, we would have the best of all possible worlds."

A. What do you think? Best? Acceptable? Why? Defend your view.

B. How might someone like Rodney, who is skeptical about markets, respond? [Hint: He might for example question the effects on the distribution of goods. Might distribution be "unfair" when markets are left alone?]

19. Whenever basketball tickets are in high demand, schools tend to allocate them on a first-come, first-served basis. Who wins and who loses with this system? What will the actual price of a basketball ticket be in this case? (Think of opportunity costs: Is the money price the only opportunity cost?) What would happen if the tickets were auctioned off to the highest bidders? Who would pay the most? Would the college gain in this case?

### ANSWERS TO CONCEPT CHECKS

1. Not really. Economists would see this store as part of several larger markets (e.g., one of many suppliers of certain products to its customers, and one of many demanders of certain items from its wholesale distributors). But one store does not constitute a "market."

2. Find \$2.30 on the vertical axis. Draw a horizontal line from \$2.30 toward the supply curve and see where the line intersects the supply curve. Go from the intersection straight down to the horizontal axis and you'll find that the quantity supplied is 1.0 (meaning 1,000 gallons per day). Then draw a horizontal line at the price of \$2.30 over to the demand curve and look for the intersection with the demand curve. Again go straight down to the horizontal axis and you'll see that the quantity demanded is 9 (meaning 9,000 gallons per day). Demand far exceeds supply at the low price of \$2.30 per gallon gas, just as you'd expect.

3. Cheaper crude oil lowers the cost of producing gasoline. Suppliers will see this as an opportunity for larger profits and will be eager to supply more gasoline to the market. The supply curve will shift outward.

4. A drop in the price of BP gasoline will increase the quantity demanded for BP gasoline (law of demand) but reduce the demand for Texaco gasoline (a substitute).

5. The substitutes - because they are alternative ways of getting to your destination - are gasoline at Quik Trip, gasoline at the Mobil station, a bicycle, gasoline tomorrow, and walking to River City. The complements are tires, service on the car, and a car stereo.

6. The restaurant is experiencing excess demand. The prices on its menu are not high enough to bring the quantity demanded into equality with the quantity supplied. Lines outside rock concerts and on bargain days at the mall mean the same thing. Whenever you see a line of customers you can interpret it as a sign of excess demand.