HW for EC 11 – about markets

This assignment is due Jan 18, 2016 by email (hard copy to be submitted in class on Jan. 19).

For the week ending Jan. 15, please read all you can about demand, supply, and markets. Use mainly Mankiw (or any standard textbook) and my lecture notes (Lectures 4, 5, 6, 6A, and 7).

In answering these questions, you may use any source – textbooks, Google, etc. – but you will get no credit if you do not cite your sources. You may organize yourselves in any way to cooperate — or compete — with each other. Please indicate briefly whether you are convinced of your answer, including the reasons as to why or why not.

Each of questions 1-5 is worth 6 pts. Questions 6 and 7 are worth 10 pts. each.  Extra-credit questions are optional.

1. Explain in your own words why opportunity cost is “the next best thing.”  Does the concept of rationality play a role in the explanation.  Explain.

2. Prove the Law of Demand, using (a) graphs; and (b) verbal arguments.

3. What is the relationship between the Law of Diminishing Marginal Utility and the Law of Demand? Explain your answer. Give a proof, if you can, using a numerical example. (Hint: Set up a table of total and marginal utilities for a given consumer, and show what happens to the quantity demanded of a good whose price has gone down.) Extra credit (5 pts.): What happens to the Law of Demand if the Law of Diminishing Returns does not hold?

4. Prove the Law of Supply, using a numerical example based on the assumption that producers-sellers aim to maximize profits.

5. What is the relationship between the Law of Diminishing Returns and the Law of Supply? Explain. Give a proof using a numerical example.  Extra credit (5 pts.): What happens to the Law of Supply if the there is Increasing Returns instead of Diminishing Returns?

6. Explain how the market (equilibrium) price is determined, using (a) the concept of “tatonnement”; or (b) the process by which individual buyers and sellers bargain with each other even though they have incomplete information on what is the correct level of the market price.(Hint: for (b), imagine that a market consists of producers and consumers, and also a third group called “market makers” who buy from producers and sell to consumers.  The market makers keep a stock or inventory of the good, and will make a deal with producers and consumers based on their best guess on the “correct” price for the good.)

7. In Mankiw, there appears to be an inconsistency between his claim that in competitive markets, individual participants cannot affect the market price, and his other claim that if the actual price is higher or lower than the market price, individual participants will or can adjust the price towards the market price.  In other words, how can an economist claim that individual market participants have no power to affect price, but then also claim that their individual pricing and buy-sell decisions will move the price to the equilibrium? Explain your answer.

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