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CHAPTER I.

what is economics?

GETTING STARTED

Working in groups of four, consider the issues below. After you have reached some conclusions, share your ideas with the whole class.

I The dictionary defines economics as "the study of the production of wealth and the consumption of goods and services in a society." List five economic issues relating to production and consumption that your national or local government has to deal with today.

2. John Maynard Keynes, one of the most influential economists of the twentieth century said, "The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else."

What do you think Keynes meant by this statement? Do you agree or disagree? Give reasons to support your opinion

VOCABULARY STUDY

The italicized words in the sentences below are found in this chapter. Study the sentences. Then identify the part of speech and write your own definition for the word on the line provided.

EXAMPLE.

He acquired his wealth in the steel industry.

acquire (V ) gain possession ok

1.The government will allocate more of its budget to health care.
allocate ( )___________

2.An alternative to putting one's savings into a bank is investing in stocks and bonds.
alternative ( ) ____

3. A high tax was placed upon luxury commodities.

commodities ( )_

 

4.The government enacted a law to control the sales of guns,
enact ( ) _____

5.After Mary lost her job, she had to forego some of the luxuries she had grown
accustomed to.

forego ( )_

6.Food and shelter make up our fundamental needs,
fundamental ( ) ______

7.When bad weather is threatening, people tend to hoard food because they are
afraid the supermarkets will be unable to get in new supplies.

hoard ( )________

8.As an added incentive, the car dealer offered a special service agreement,
incentive ( )_____

9.The teacher's intervention prevented the two boys from getting into a fight,
intervention ( )

10.They optimized their profits by reinvesting them in the company,
optimize ( )

11.The telephone company is promoting a new service for its customers,
promote ( )

12.A basic knowledge of economics is relevant to everyone,
relevant ( )

13.Since the floods last summer, there has been a scarcity of grain products on the market.

scarcity( )________

 

In each set of words, cross out the word that does not have a similar meaning to the first. Compare your answers with another student. Discuss why the words are similar.

1.acquire get obtain question

2.allocate assign attract set aside

3.alternative change option possibility

4.commodity item market product

5. consumption manufacture purchase use of

of items of items items

6.enact establish represent specify

7.forego precede renounce sacrifice

8.fundamental basic essential secondary

9.hoard accumulate exchange save

10.incentive encouragement occurrence stimulus

11.intervention familiarity imposition interference

12.optimize make efficient make necessary make useful

13.promote publicize obstruct advocate

14.relevant applicable dependable fitting

15.scarcity gap lack terror

 

ORGANIZING OUR THOUGHTS

In groups of four, discuss the following questions and report back to the entire class on your major conclusions.

1. Why should everyone understand basic economics?

2. Economics has been called "the study of scarcity and choice." How does this relate to your budget for the week? How does this relate to your nation's budget?

3. How do different economic systems solve the problem of scarcity? Give specific examples.

 

ACTIVITY 1

Scan the following reading for answers to the questions below:

What two groups are discussed?

How were they different from each other?

What is a "Favorable balance of trade"?

What is "laissez faire" and with which group is the term associated?

The First Modern Economists

The Mercantilists. Between the 16th and 18th centuries, the major countries of Europe believed in the economic theory of mercantilism. Mercantilists argued that nations should behave as if they were merchants competing with one another for profit. Accordingly, governments should support industry by enacting laws designed to keep labor and other production costs low, and exports high. In this way the nation could achieve what was called a "favorable balance of trade."

"Favorable balance of trade" described a situation in which exports exceeded imports. The excess, which was like profits to a merchant, would result in an increase in the nation's supply of gold or silver. And, as most people agreed in those days, the true measure of a nation's wealth was its hoard of gold or silver.

To achieve Favorable trade balances, the major European powers sought to acquire colonies. Colonies, it was thought, could provide the "mother country" with cheap labor, raw materials and a market for its manufactured goods.

In an effort to attain these goals in their American colonies, the British, for example, enacted the Navigation Acts. The Navigation Acts protected British industry by prohibiting the colonies from producing certain goods like hats, woolen products and wrought iron. The laws also listed certain "enumerated articles" (mostly raw materials) which could not be sold to buyers in countries other than England.

Resentment towards the Navigation Acts was so great that they are regarded as one of the principal causes of the Revolutionary War.

Today there are people who still argue that their country should promote a "Favorable balance of trade," that their national government should do what it can to restrict imports and promote exports. For that reason, they are often described as neo-mercantilists or "new" mercantilists.

The Physiocrats. For one group of 18th-century French philosophers and economists, the suggestion that nations should go out of their way to protect business and industry made no sense at all. These were the physiocrats.

The physiocrats argued that the products of agriculture and other natural resources were the true source of wealth. Since these were God-given, it made little sense for government to go out of its way to help business and industry increase profits. For similar reasons, they opposed government efforts to promote a "favorable balance of trade."

In other words, since real wealth came from the land, it followed that the wisest thing government could do would be to keep its hands off business and let nature take its course. This idea was expressed in the slogan "laissez faire," (let people do as they choose)

Interestingly, the 200-year-old argument between those favoring regulation of the economy and those supporting laissez faire is still with us. Whether the problem involves individuals (like those living in poverty and unemployment) or institutions (such as a rising tide of business or bank failures), there are those who find the solution in government intervention, and others who favor "laissez faire." letting natural economic forces take their course.

 

QUESTIONS FOR UNDERSTANDING

Working with a partner do the following tasks. Share your ideas with the whole class.

Write a definition for each of the two groups of economists discussed in the article.

Identify the neo-mercantilists.

Can you name any individuals or groups of people in your country or abroad who could be described as neo-mercantilists?

In the United States today, opinion about economic policy continues to be divided into two schools of thought similar to those described in the article. Is this true for your country? Provide examples to support your opinion.

 

ACTIVITY 2

Before you read the following article, skim through it quickly and underline two sentences that convey the main ideas.

Supermarket Economics

Supermarkets offer valuable economic lessons. The modern supermarket illustrates in a small way how the market system operates in the economy as a whole. Each supermarket has tens of thousands of items of various sizes and brands. Store owners and managers compete for the customers' dollars by trying to offer the best service and the greatest variety of goods possible at prices their customers are willing to pay. The modern supermarket provides everything from basic foods to gourmet items from any place in the
world. Customers can shop in the supermarket's deli or make their own lunch at a soup-and-salad bar. Supermarkets also sell cosmetics, toys, small appliances and even videos of recent movies. They attempt to maintain a bright and cheerful atmosphere that will make shopping pleasant for large numbers of customers.

Information about consumer preferences in this huge mix of products is generated by a simple procedure. Consumers take their selection to the checkout line. Checkout clerks enter information about the sale on the store's computer by passing the product's bar code across a scanner.

The store responds to differing consumer preferences for health, economy, convenience, and vanity by stocking the goods consumers prefer. Products that fail to satisfy are replaced by more attractive products. "Winners" are selected and the "losers" gradually lose shelf space. Ultimately producers either improve their products or pass from the scene. The consumer is really king. The market registers their preferences and reconciles supply with demand.

QUESTIONS FOR UNDERSTANDING

Working with a partner, answer the following questions:

1. The market generates information about wants and provides incentives to pay attention to consumers' preferences.

a. How does the market generate information about preferences?

b. What arc the "incentives" referred to in question 1?

2. Why is "self-interest" significant to the operation of a market system?

3. The article states that "...losers gradually lose shelf space. Ultimately producers either improve their products or pass from the scene."

a. Who are the "losers?"

b. Explain the meaning of the second sentence in question 3.

 

ACTIVITY 3

Scan the following article to define the terms below;

opportunity costs money cost production cost foregone earnings

Compare your definitions with a partner. Then .share them with the whole class. Read the article carefully and complete the discussion questions that follow.

Opportunity Costs

Economists are concerned with how we make choices in a world of
scarce resources. Individuals, families, business firms and governments all must make decisions about how best to allocate the limited resources at their command.

When resources are limited, choices are limited as well. This means that
the decision to have one thing is, at the same time, the decision not to
have something else. Suppose, for example, that a government chose to pay for an increase in the size of its air force with the money it saved by building fewer schools. In that instance an increase in defense was paid for by a reduction in the number of schools.

The opportunity cost of any decision is the value of the next best alterna
tive that is given up. It is the relevant cost to use when trying to make the
best (optimizing) decision. This is true whether the decision relates to
consumption, production, or investment.

Even though we usually think of the money cost of producing something, the opportunity cost provides a much more sensible way of measuring economic cost. If more resources (labor, plastic, steel, etc.) are used to increase the production of computers, then the production of something else that requires those same resources (such as stereos) must be cut back.

If every computer requires the same resources as two stereos, then the
opportunity cost of producing a computer is two stereos. It makes sense
to evaluate the cost in terms of what we don't get because we're produc
ing computers.

In fact, the concepts of money cost and opportunity cost are very closely tied together in a market economy. In general, a good that has a high opportunity cost will also have a high money cost. This is because price is one way to allocate resources among competing uses. Let's think of some of the ways that opportunity costs play fundamental roles in our lives. Many high school students consider going to college for four years after graduating from high school. What is the cost of acquiring a college education?

Obviously, the cost of tuition, the cost of books and other supplies, and
the cost of living in a dorm represent the money cost of going to college.
The other uses this money might have been put to represent its opportunity costs. But what else is a cost of going to college? If a student did not go
to college, then he or she would most likely find a job instead.

The money that those who choose college might have earned during their
years of study is described by economists as foregone earnings. Foregone
earnings represent another, very important cost of a college education.
Thus, the opportunity cost of going to college is the goods and services
represented by the money cost of the education, plus the value of the fore
gone earnings.

Another example of this concept can be seen in the opportunity cost of
capital. Let us assume that a manufacturing firm is considering the addition
of microwave ovens to its product line. What will it cost to produce them?

In addition to materials and labor costs, the firm must also consider the return it might receive if, instead of using those funds to manufacture microwaves, it put the money into U.S. Treasury bonds or some other safe investment (its opportunity cost). Let us assume, for example, that the firm could earn 10 percent on the money simply by investing it in government bonds. That being the case, the complete cost of production would have to include both production costs and [he opportunity cost of the firm's capital.

 

QUESTIONS FOR UNDERSTANDING

Discuss the following questions in groups of four.

1.Having read the article carefully, look at the definition you wrote earlier for
opportunity cost. If you are not completely satisfied with that definition,
write another at this time.

2.What was the opportunity cost of your last major purchase? What was the
opportunity cost of a decision you made to spend your time a particular way?

3. What is the opportunity cost involved in a decision to continue schooling after graduation from high school?

4. What is the opportunity cost involved in a decision to forego schooling in favor of entering the world of work immediately after graduating from high school?

5. The Firm referred to in the last two paragraphs of the reading estimated that it would have to invest US$500,000 in order to produce microwave ovens. Production costs would add another USS200.000 annually. The firm estimates that it could sell about US$225,000 worth of ovens each year. Would it be wise for the firm to manufacture the microwave ovens? Explain your answer.

 

ACTIVITY 4

 

A national budget allocates funding for social services and national defense, common for policymakers to debate how much money should go to guns (national defense) and how much to butter (social programs).

The following activity portrays in graph-form these opposing concerns for Kingdom of Ecomania (fictitious).

Working with a partner, examine the graph and discuss the questions that follow

What is the maximum quantity of butter that can be produced in Ecomania in
a single year?

If Ecomania produces 6,000 tons of butter, how many guns can it produce?

What is the opportunity cost in guns if Ecomania produces 6,000 tons of butter?

What information, missing in this graph, would you need before deciding or
the best production combination for Ecomania?

 

 

 

 

 

 

 

 

CHAPTER II.

 

SUPPLY, DEMAND AND MARKET PRICE GETTING STARTED

A market economy is one that relies upon buyers and producers to determine production, consumption, investment and savings. Working in groups of four, complete the tasks below and share your ideas with the whole class.

Think of three examples of new products that have come on the market in
your country because of consumer demand. As these products have been on
the market, have they become more expensive or less expensive?

Think of three products or services that have gone off the market or become
difficult to obtain in your country because of declining demand.

 

VOCABULARY STUDY

The italicized words in the sentences below will be found in this chapter. Study the sentences. Then in the list that follows, match the words with their meanings.

1.Their investments were not attuned to their future goals.

2.The workers conceded on salary increases in order to retain their retire-
ment benefits.

3.With the closing of several of its branch offices, the economic problems of the company were quite conspicuous.

4.If production costs remain constant and the market demand increases, the company can count on higher profits.

5.Sociologists tend to be more interested in contemporary problems than they are in the past.

6.Since conventional approaches were not proving successful, the company was experimenting with a completely new strategy.

7.Parents of college-aged children find their savings diminishing because of the high cost of university education today.

8.The introduction of high quality, low cost foreign goods into the local market upset the equilibrium of the economy.

9.With recent court decisions guaranteeing their rights, that interest group is exerting more political influence.

10.The research division of the company functions as a laboratory.

11. Following a long, successful career, she looked forward to her retirement and more time for leisure.

12.Though single-owner businesses remained profitable, their influence upon the economic policies of the city was marginal.

13.People can live successful lives if they learn how to maximize their potential and not let their weaknesses get in the way.

14.Unfavorable reports on the new product stifled consumer interest.

15.When interest rates at the banks are low, people have the tendency to spend their money rather than to put it into savings.

16.Though he graduated at the top of his class, he never fulfilled his potential as a lawyer.

 

1.attuned a .borderline

2.concede b. exercise influence

3.conspicuous c. possibility, promise (n)

4.constant d. decrease, lessen

5.contemporary e. yield, give up

6.conventional f. operate

7.diminishing g. increase to greatest amount

8.equilibrium h. in accord

9.exert i. inclination; likelihood

10.function j. ordinary, usual

11.leisure k. of the same time

12.marginal 1. unchanging, at the same level

13.maximize m. easily seen

14.stifle n. equal balance

15.tendency o. free time

16.potential p. prevent; suppress

With a partner, write original sentences using each of the sixteen words.

 

ORGANIZING OUR THOUGHTS

In groups of four, discuss possible answers to the questions below and report back to the whole class on the ideas exchanged by your group.

 

What affects the demand for goods and services in a market economy?

What affects the supply of a particular good or service?

How do demand and supply interact to determine prices?

How do profits, economic self-interest and other incentives keep a market economy growing? Give specific examples.

 

ACTIVITY 1

 

Scan the next article for the answers to the following questions:

With which group are Adam Smith's ideas most in agreement: the mercan
tilists or the physiocrats?

What is another term for Smith's invisible hand! How does it operate in a nation's economy?

Read the article carefully and complete the exercise that follows.

ADAM SMITH AND THE WEALTH OF NATIONS

1)1776, the year that Americans associate with the signing of the Declaration of Independence, also marked the publication in England of one of the most influential books of our time, The Wealth of Nations, Written by Adam Smith, it earned the author the title "The father of economics."

2)Smith objected to the principal economic beliefs of his day. He differed with the physiocrats who argued that land was the only source of wealth. He also disagreed with the mercantilists who measured the wealth of a nation by its money supply, and who called for government regulation of the economy in order to promote a "favorable balance of trade."

3)In Smith's view, a nation's wealth was dependent upon production, not agri
culture alone. How much it produced, he believed, depended upon how well it combined labor and the other factors of production. The more efficient the combination, the greater the output, and the greater the nation's wealth.

4)The heart of Smith's economic philosophy was his belief that the economy would work best if left to function on its own without government regulation. In those circumstances, self-interest would lead business firms to produce only those products that consumers wanted, and to produce them at the lowest possible cost. They would do this, not as a means of benefitting society, but in an effort to outperform their competitors and gain the greatest profit. But all this self interest would benefit society as a whole by providing it with more and better goods and services, at the lowest prices.

5)To explain why all society benefits when the economy is free of regulation, Smith used the metaphor of the "invisible hand":

"Every individual is continually exerting himself to find the most advantageous employment for whatever capital he can command. It is his own advantage, and not that of society, which he has in mind, .. . but he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention, for the pursuit of his own advantage necessarily leads him to prefer that employment which is most advantageous to society."

5)The "invisible hand" was Smith's name for the economic forces that we today would call supply and demand, or the marketplace. He sharply disagreed with the mercantilists who, in their quest for a "favorable balance of trade," called for regulation of the economy.

6) Instead, Smith agreed with the physiocrats and their policy of "laissez faire," letting individuals and businesses function without interference from government regulation or private monopolies. In that way, the "invisible hand" would be free to guide the economy and maximize production.

7) The Wealth of Nations goes on to describe the principal elements of the economic system. In a famous section, Smith turned to the pin industry to demonstrate how the division of labor and the use of machinery increased output.

"One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations...."

8)Although modern technology has improved the methods by which pins are
produced, the principles pertaining to the division of labor remain unchanged.

9)Similarly, other sections dealing with the factors of production, money and
international trade are as meaningful today as when they were first written.
Smith's The Wealth of Nations contains some of the best descriptions of the
principles upon which the economic system of the United States is based.

Look back at the text and identify what the following words refer to. The first item is already done for you.

1.it (paragraph 1) THE WEALTH OF NATIONS

2.who (paragraph 2)

3.it (paragraph 3)

4.combination (paragraph 3)

5.In those circumstances (paragraph 4)

6.them (paragraph 4)

7.it (paragraph 4)

8.this (paragraph 5)

9. their (paragraph 5)
10. they (paragraph 9)

 

ACTIVITY 2

Working with a partner, read the description of tables and graphs below and answer the questions that follow.

Understanding Supply and Demand Tables and Graphs

Economists often use tables and graphs to illustrate and explain their work.

Tables. A table is an orderly arrangement of facts and figures. Information is arranged horizontally (or across) in rows, and vertically (up and down) in columns. The following is an example of a table:

Demand Schedule for Corn, March 29, 199 _

At a Additional Total

price per buyer demands demanded

Buyer bushel (thousands) (thousands)

1 US$3.50 80 80

2 3.25 20 100

3 3.00 20 120

4 2.75 20 140

5 2.50 20 160

6 2.25 20 180

7 2.00 20 200

This kind of table is called a "demand schedule." It tells us how many bushels of corn buyers would take, at a variety of prices, at a particular point in time.

At a price of US$3.50 per bushel, for example, one buyer would be willing to buy 80,000 bushels. If the price were US$3.25 per bushel, however, a second buyer would step into the market and buy 20,000 bushels. This, plus the 80,000 bushels demanded by the first buyer, brings the total to 100,000 bushels at that price. (Naturally, the first buyer would also be willing to pay US$3.25 instead of US$3.50 for the bushel).

If the price were US$3.00 a bushel, another buyer would step in and take another 20,000 bushels. At that price, the total number of bushels demanded would be 120,000.

How many bushels of corn would be demanded at US$2.50 per bushel? How many at US$2.00 per bushel?

The supply side of the same corn market is summarized in the following table.

Supply Schedule for Corn, March 29, 199 _

Price per Additional Total

bushel seller offers supplied

Seller (US Dollars) (thousands) (thousands)

1 3.50 20 200

2 3.25 20 180

3. 3.00 20 160

4. 2.75 20 140

5. 2.50 20 120

6. 2.25 40 100

7 2.00 60 60

 

As you can see, the table summarizes the relationship between price and the supply of corn.

How many bushels of corn would be offered for sale at US$2.00 per bushel? At US$3.50 per bushel?

At US$2.75 per bushel?

 

Graphs.A graph is a diagram that shows relationships.

Illustrating Supply and Demand With a Graph

The bottom line, or horizontal axis, represents the quantity (number of items) that would be demanded. The side, or vertical axis, represents the price. If you examine the graph carefully, you will see that the dots represent total demand at the prices in the demand schedule above.

Connect the dots and label the line "D" to complete the graph.

Lines on a line graph .are called curves. Since what you have drawn describes the demand for something, it is called a demand curve.

Notice that the demand curve slopes downward from left to right. This shows us that the number of items demanded is greater at a lower price than at a higher price.

The supply curve is drawn in the same way.

Using the information contained in the supply schedule, plot the total quantity that will be supplied at each price on the graph above.

Connect the points to complete the supply curve. Label the curve "S." Can you explain why the supply curve slopes upward, from left to right?

Finding The Market Price. The supply and demand curves tell us what buyers and sellers were willing to do in the corn market. They do not tell us the market price. That is the price at what which the corn would actually sell. By finding the point where supply and demand curves intersect (cross), we can determine the market pricethe price where buyers will purchase all that producers are willing to sell.

Label the point where the supply and demand curve intersect "M."

If you completed the graph correctly, you found the market (or equilibrium) price to be US$2.75 for 140,000 bushels of corn.

 

QUESTIONS FOR UNDERSTANDING

In groups of four discuss the following problems. Share your answers with the whole class.

1.Which buyers purchased the corn?

2.Which of the sellers sold the corn?

3.Were any buyers unable to buy corn? Any sellers? Explain your answers.

 

ACTIVITY 3

Before you read the article carefully, scan through it to find the answers to the following questions.

What product is used to demonstrate the principle of supply and demand?

What is the specific market that is discussed?

Supply and Demand Revisited

As we have already learned from the textbook, we can represent the decisions of buyers with the demand curve and the decisions of sellers with the supply curve.

The Demand Curve. This curve shows the relationship between the price of a good or service and the quantity consumers will buy, at a specific time, and holding everything else constant. Demand curves usually slope downward from left to right. This means that consumers are more willing and able to buy larger quantities of goods and services at relatively lower prices. This can be explained by the principles of diminishing marginal utility. After consuming a certain amount people get less and less satisfaction from each additional purchase. For example, the first ice cream cone consumed at the baseball game is great; the second is good; the third one is fair; the fourth one was "too much"; and the fifth one made you sick. Clearly we would not choose to pay as much to feel sick (the fifth cone) as we would pay to feel great (the first cone).

Believe it or not, at some point the principle of diminishing marginal utility applies to almost everything we consume. As I buy more clothes I get better wear from the clothes 1 own, my wardrobe becomes more flexible, and my "satisfaction" or "utility" may increase. But sooner or later, the utility of having additional clothes will diminish. For example, you don't get your money's worth because you seldom wear certain outfits. Because of diminishing marginal utility, the demand curve for a commodity will show that more will be demanded only at lower prices.

The Supply Curve. The supply curve shows the relationship between the price of a good or service and how much sellers will offer for sale at a specified time and holding everything else constant. In general, supply curves slope upward from left to right. This means that at relatively high prices, businesses will naturally want to produce and sell more. At lower prices less will be produced and supplied. For example, suppose we are making ice cream in our kitchen to sell at Friday's baseball game. With the available kitchen equipment we are able to store ingredients used (the cream, etc.) and freeze 20 gallons of finished ice cream. But we want to produce more. In order to do so we have to find additional storage space. We could buy dry ice and pack the ice cream and the ice in a big metal tub purchased from the hardware store. This would allow us to increase production to, say, 40 gallons. But the last 20 gallons now cost more to produce than the first 20 gallons did because we had to buy the ice and the tub in addition to the cream. Because it costs more to increase production, if we hold everything else constant (such as the size of the refrigerator), economists say that the marginal cost of production will tend to increase after some point.

It is easy to see why the supply curve slopes upward. You produce ice cream to make a profit from sales. Since it costs more per unit to produce more- than 20 gallons, you will find it profitable to produce the additional 20 gallons only if the selling price goes up. Thus, supply increases only as price increases.

Equilibrium Price and Quantity. Now we see that buyers and sellers are in conflict: Buyers will only purchase more at lower prices, while sellers will only sell more at higher prices. Can they reach an agreement?

7) Yes. Their agreement is called the equilibrium price and quantity. It is that price-and-quantity combination of the good in question at which there is no tendency to change unless something else changes. In the example above, it is the price of ice cream produced and sold, from which there is no tendency to change unless something else changes.

Is any and every price we see an equilibrium price? No. The difference
between equilibrium and nonequilibrium prices is that equilibrium prices will
remain unchanged as long as nothing else changes, while nonequilibrium
prices will change even when nothing else changes.

The graph shows how much ice cream you will supply and demand at each
price. Is US$.75 per ice cream cone an equilibrium price? According to the
supply curve, at US$.75 you would produce and supply 40 gallons of ice
cream and still make a profit. Even though the cost per cone is higher when
we produce 40 gallons, US$.75 is even higher. You will not be able to sell all
40 gallons, however, because the baseball crowd will buy only 10 gallons, leav
ing an excess quantity supplied of 30 gallons.

To get consumers to buy some of this excess supply from you, you must
reduce the price. When you lower the price, more people will want to buy ice
cream from you. Nevertheless, you will probably decide to produce fewer gal
lons next week to avoid increasing your marginal costs of production. (Look at
how the quantity offered for sale changes as price declines. What is the con
nection with increasing marginal cost? Hint: Everything is working in reverse

here.) Seventy-five cents is a nonequilibrium price because there is excess supply, which produces a tendency to change price and quantity even though nothing else has changed.

Suppose you go back to the game next week and try to sell ice cream at US$.25 a cone. Is US$.25 an equilibrium price? Well, at US$.25 you can only produce 10 gallons of ice cream and make a profit (again, because of the increasing margin al cost of producing more). But, as shown by the demand curve, the baseball crowd will want to buy 40 gallons at a price of US$.25. The result is an excess quantity demanded of 30 gallons. There will be some people who will want to buy at that price who will be unable to because you will run out of ice cream. You now know that next week you can sell more than 10 gallons and at a price higher than US$.25. Thus, US$.25 is not an equilibrium price.

What is the equilibrium price and quantity that will not change unless something else changes? We know the equilibrium price is greater than US$.25 and less that US$.75, and we know the equilibrium quantity is greater than 10 gallons and less than 40 gallons. We also know that price declines when there is excess supply and rises when there is excess demand, even when nothing else changes. So the equilibrium price and quantity must be at that point at which there is no excess supply or demand. It is where supply equals demand. This occurs at a price of US$.50. At that price you will profitably supply 25 gallons, and the crowd will demand 25 gallons. There is no excess. You sell all you want to sell; the crowd buys all it wants to buy; and there is no tendency for either price or quantity to change. Next week and forever you will come to the stadium and sell 25 gallons of ice cream for US$.50 a conethat is, unless something else changes.

 

QUESTIONS FOR UNDERSTANDING

Working with a partner, do the following tasks.

1. Write a definition for the following terms:

a. diminishing marginal utility

b. marginal costs of production

c. equilibrium price and quantity

 

In the final sentence of the article, the author says that the equilibrium of price and quantity will remain the same forever "unless something else changes."
Identify what specific changes might alter the equilibrium?

If you were to rewrite this article for your country, what product and what market would be more appropriate for you to use to demonstrate supply and demand?

 

ACTIVITY 4

Complete the following activity with a partner.

More Problems in Supply, Demand and Market Price

In interpreting demand curves, it is necessary to understand the concept of elasticity. Elasticity describes how price changes affect the quantity demanded. If a price change has little effect on the quantity demanded, demand is inelastic. If the price change directly effects on the quantity demanded, we say the demand is elastic.

1. The supply and demand for lettuce.

a. Label the demand curve "D," the supply curve "S."

b. What is the equilibrium price?

c. Why does the price of lettuce fluctuate in the grocery store?

d. Illustrate on the graph what happens when farmers have a bumper lettuce crop. How does the price change? The quantity sold?

e. Is lettuce an elastic or inelastic good? Explain.

f. What other foods are affected by the price of lettuce? Why?

 

2. The supply and demand for designer perfume.

Price (Dollars per Ounce)

a. Label the demand curve "D," the supply curve "S."

b. What is the market price? Label it "M" on the graph.

c. If perfume were selling for US$12.00 a bottle, what would be the quantity
demanded?
What would be the quantity supplied?

d. If perfume were selling for US$30.00 a bottle, what would be the quantity
demanded?

What would be the quantity supplied

e. If the cost of producing perfume were to increase, what would happen to
the price and quantity sold? Show this change on the graph. Label the new
supply curve "SI" and the new price "Ml."

f. If tastes change and consumers desire more of the product, show what
would happen in the marketplace. Draw a new demand curve and label it
"D2." Label the new market price "M2."

 

3. Plotting supply and demand curves.

Use the grid below to plot the supply and demand curve for corn based on the following data:

At a price of Buyers will take Sellers will offer

(per bushel) (thousands) (thousands)

US$ .50 425 25

.75 350 80

1.00 295 135

1.25 250 175

1.50 215 215

1.75 170 240

2.00 115 275

2.25 70 310

2.50 45 325

a. What would the market price be at the equilibrium point?

b. How many bushels would be sold at that point?

c. Draw new supply and demand curves showing the direction they will shift
for each of the following hypothetical events. Label them Cl, C2, and C3.

Cl. Last week the Surgeon General of the United States announced that eating corn protects you from the common cold.

C2. Suppose that the Surgeon General had announced that eating corn will turn the whites of your eyes yellow.

C3. A strange plant disease ruined a large portion of the nation's corn crop.

 

ACTIVITY 5

 

Scan the following article for the answers to the questions below.

In what way is the economist Say similar to the astronomer Ptolemy?

In which centuries did Say live?

What was Say's nationality?

What connection did Say have with Adam Smith?

Read the article carefully and discuss the questions that follow.

 

Jean Baptiste Say (1767-1832)

Say's Law of Markets

 

For hundreds of years, the science of astronomy was frozen by the widely believed theories of the second century Greek astronomer, Ptolemy. According to Ptolemaic theory, the Earth was the center of the universe. It was not until the 16th century that Europeans, accepting the work of Galileo and Copernicus, were persuaded that the Earth, and all the other planets, rotated around the sun. In much the same way, the doctrine known as Say's Law, stifled advances in the study of economics for well over 100 years.

An admirer of Adam Smith, John Baptiste Say's Treatise on Political Economy (1803) helped to introduce The Wealth of Nations to his native France. In the course of explaining Smith's theories and the role of markets in satisfying human wants, the author developed what came to be known as Say's Law. According to Say's law, "production creates its own demand." In other words, people produce and sell goods and services in order to buy the things they want. If buyers no longer want certain products, sellers will stop producing them, and shift into something that is in demand.

Now, if only those goods and services actually in demand are produced, and the income received from the sale of those products is ultimately used by managers and workers to buy the things they want and need, it follows that supply created its own demand. In other words: there could be no such thing as overproduction, or longterm unemployment. Temporary overproduction and unemployment, yes. Long term, never.

The onset of the Great Depression of the 1930s, with its widespread unem
ployment and overproduction that dragged on for years, finally put Say's law to rest. Although some economists continued to agree with Say that "in the long run," the market would bring supply, demand, and employment into balance, most agreed with the British economist J.M. Keynes who pointed out that "in the long run we are all dead." By that he meant pressing problems require immediate attention. We can't wait for long-term solutions.

 

QUESTIONS FOR UNDERSTANDING

In groups of four, consider the following question's; then share your ideas with the whole class.

What is Say's Law? Give a specific example of Say's Law drawing from your
country's experiences?

The Great Depression revealed some problems in Say's Law. What were they?

 

ACTIVITY 6

Form into groups of four. Two members of the group will be responsible for reading the selection about Thorstein Veblen and the other two will read about Frank Knight. After the two subgroups have finished the reading, join together as a group of four and complete the questions that follow the two articles.

 

Thorstein Veblen and Frank Knight

Critic and Defender of the Market System

THORSTEIN VEBLEN (1857-1929)

In 1899 conventional wisdom of the economists of that day was jolted with
the publication of Veblen's The Theory of the Leisure Class. A professor of eco
nomics at the University of Chicago, Veblen said much about contemporary
economics and social behavior that angered and upset his colleagues.

In what may be his most famous contribution, Veblen challenged the assumptions
built into the laws of supply and demand. One of these assumptions was that of
"consumer sovereignty." Veblen questioned the assertion that the consumer was a
king who demanded and received the best goods and services at the lowest prices.
Instead, he argued, consumers were subject to all kinds of social and psychological
pressures that led them to make some very unwise decisions.

To illustrate, he coined the term conspicuous consumption to describe the ten
dency of the "leisure class" (the wealthy) to buy goods and services simply to
impress others. This, in turn, led middle class consumers, and even the poor,
to imitate the wealthy by buying goods for similar purposes. When that
occurred, it was possible for the law of demand to be reversed. Quantity
demanded increased at a high price rather than at a low one. For example, the
demand for a 1-ounce bottle of an unknown brand of perfume priced at US$1
was likely to be less than the same perfume selling for US$ 15 an ounce.

As for the other side of the market, Veblen argued that the desire for profits
drove business interests into doing unscrupulous things. Some of these includ
ed efforts to eliminate competition, restrict output, build ever larger combina
tions of existing firms, and separate those who owned America's corporations
from those who managed them. This, he predicted, would result in wasted
resources and the inability of the economy to reach its full potential. From
these observations, Veblen concluded that laissez-faire capitalism was proba
bly destined to be replaced in the long run with a system more attuned to the
needs of the People.

 

FRANK KNIGHT (1 885-1 972)

A professor of economics at the University of Chicago, Frank Knight advocat
ed free enterprise and laissez faire politics. Knight pointed out that except for
the basic necessities of life the purchase of anything could be described as
"conspicuous consumption." Since, he noted, even Veblen would have conced
ed that people need more than the bare necessities, who was to say which
purchases were reasonable? Should the government or some other higher
authority decide what would be offered for sale? Of course not, Knight con
cluded, consumer demand ought to determine what goods and services would
be provided.

Turning to the supply side of the market, Knight defended profits as the dri
ving force behind business. The quest for profit would move business to pro
duce whatever the economy wanted. Meanwhile, the inescapable punishment
of financial loss awaited those firms who failed to meet the market's
demands. In his famous work, Risk. Uncertainty and Profit (1921), Knight
answered critics who, like Veblen, had questioned the legitimacy of profits.

Profits, he said, were the reward earned by business for accepting the uncer
tainties of the market. In this he distinguished between risk (which can be pre
dicted and against which one can be insured) and the uncertainty of events
that cannot be predicted. Everyone, for example, faces the risk of illness and
can be insured against it. But sweater manufacturers can never know with cer
tainty that the styles that they are producing today will still be in demand
when they appear in the stores six months from now. Therefore, those manu
facturers who guess correctly are entitled to the rewards they earn.

Meanwhile, those who produced the wrong style or color will be motivated to
do better next season or face ruin.

Economists and others still debate the issues raised by Thorstein Veblen's
challenges to the market system and Frank Knight's responses to them. But
don't take our word for it. Pick up today's paper or news magazine, and see
for yourself.

 

QUESTIONS FOR UNDERSTANDING

In groups of four, the students who have read about Veblen and the students who have read about Knight will complete the following questions together.

1. Look at the statements below and determine if they refer to Veblen or Knight
or both of them.

a. Supported laissez faire economics

b. Taught Economics at the University of Chicago

c. Predicted the separation of ownership from management of business
organizations

d. Coined the term the "leisure class"

e. Believed business profits were earned in return for accepting the uncertain
ties of the market

f. Opposed laissez faire economics

g. Believed consumers made unwise choices

h. Supported the consumer's right to determine what should be on the market

i. Found acceptance by most economists of his day

j. Believed that people in business could gain profits by giving consumers what

they wanted

k. Believed that people in business could gain profits by limiting production

1. His ideas are still influential today

2.The two students who have read about Veblen will explain to the other students
what he meant by "conspicuous consumption." Collectively consider whether
it is a factor in today's economy? Provide evidence to support your opinion.

3.The two students who have read about Knight will explain to the others what
distinction he made between risk and uncertainty. Collectively consider how a
business might limit risk or uncertainty and prevent financial loss?

 

 

 

 

 

 

 

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1. Chapter I.....3

2. Chapter II....13

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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(16- 28 2003 .)

 

 

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