ANSWERS TO SELECTED QUESTIONS:

APPLICATIONS OF SUPPLY AND DEMAND

Private demand refers to demand by the private sector, that is, people and businesses not owned or operated by the government.
The government budget deficit is the amount of money that the government borrows each year when it spends more than it collects in taxes.

2. Draw graphs similar to Figure 1 to show the effects of an increase in government spending on computers. How would this increase affect total production of computers and the number bought by the private sector? (Ignore the effects of higher taxes or government borrowing to pay for the increase in spending.)

(Draw a graph like Figure 1 (page 125), but show an increase in demand instead of a decrease.  Show that the increase in demand for computers by the government raises the equilibrium price, raises the quantity supplied, and reduces the quantity demanded by the private sector.)

3. Draw graphs to show the effects of an increase in government spending financed by an increase in taxes, assuming that the government spends the money on schools and that the higher taxes lead people to eat at restaurants less often.

 (Draw graphs to show demand increasing for the things the government buys, such as schools (more teachers, school buildings, and equipment), raising their prices and outputs, and demand falling for restaurant meals, reducing restaurant prices and restaurant output.)

4. Suppose that the government raises its budget deficit by cutting taxes by $100 per person without reducing spending.  Suppose that people use all their extra money from the tax cut to buy video games. What are the effects on
a. The interest rate?
b. Borrowing by the private sector?
c. Prices and output of video games?

a.  The increase in government borrowing would raise the demand for loans as in this graph, raising the equilibrium interest rate from i1 to i2.
b.  Borrowing by the private sector would fall to the amount shown in  this graph.  The increased government borrowing would crowd out the private sector borrowing (because the quantity of loans demanded by the private sector falls as the interest rate rises).  Although total loans rise from 200 to 225, private borrowing falls from 200 to 125 because government borrowing increases by more than the rise in total loans.
c.  The demand for video games would increase, raising the price and output of video games.
 

5. (More difficult) Repeat Exercise 3 but assume that people pay higher taxes by saving less rather than spending less at restaurants. How does this affect the interest rate and the quantity of loans? (Hint: a fall in savings reduces the amount of money available for banks to lend, so it lowers the supply of loans.

The demand for schools rises as in Question 3, but the demand for restaurant meals does not fall.  Instead, the the fall in savings decreases the supply of loans (as people save less, they, or their banks, have less to lend) raising the interest rate.
 

6. (More difficult) The government raises its budget deficit by cutting taxes by $100 per person without reducing spending.
a. How does this affect the demand for loans? How far does the demand curve shift?
b. Assume that people save all of the extra money that they get from the tax cut. (They put all this money into a bank account.) Also assume that banks want to lend this money. Show how this increase in saving affects the supply of loans.
c. Combine parts a and b above; how does the tax cut affect the interest rate?

a. The demand for loans increases as the government increases borrowing to compensate for the tax revenue it loses. The demand curve shifts rightward by the amount of the tax cut.  (This alone would raise the interest rate.)
b. If people save all the extra money they get from the tax cut, the supply of loans would increase as in the graph.  The supply of loans would shift rightward by the amount of the tax cut. (This alone would lower the interest rate.)
c. The demand and supply of loans increase by the same amount, so the equilibrium quantity of loans rises, but the interest rate remains unchanged, as in the graph.
 
 

7. Draw a graph to show the effect on the prices of farm products of government programs that pay farmers to reduce output.

The programs reduce supply and thereby raise prices of farm products and reduce their output as in this graph.
 

8. Draw a graph like Figure 4 (page 130) to show why the price of milk would fall if the government were to eliminate its price support program.

Prices of farm output would fall to their equilibrium levels.
 

10. A local cafe adds a $1 “cleaning fee” to the $2 price of each beverage, so the total cost of a beverage is $3.
(a) Draw a demand curve for beverages at the cafe, and show the quantity demanded at the $2 price.
(b) Show how the demand curve changes if the cafe eliminates the cleaning fee.
(c) Suppose the cafe eliminates the cleaning fee but raises the price of a beverage to $3. How many beverages will it sell? Will it sell more or fewer beverages than it sold when it charged a $2 price and a $1 cleaning fee?

(b) The demand curve shifts upward by $1 when the cafe eliminates the cleaning fee.
(c) It will sell the same number of beverages as before, when each beverage cost $2 plus a $1 cleaning fee.
 

11. People can reach the Island Restaurant only by boat. The round trip used to take one hour, but now it takes only 40 minutes. Draw a graph to show how this change affects the demand for meals at the Island Restaurant if all potential diners value their time at $12 per hour.

Buyers value the 20 minutes they save at $4, so the demand curve shifts upward by $4.  In other words, the highest price that buyers are willing to pay for meals rises by $4 because buyers implicitly pay $4 less in a time price when they go to the restaurant.  The equilibrium moves from point A to point B, so the price rises from P1 to P2.  So the price rises, but it rises by less than $4 (less than the upward shift in the demand curve).
 

12. Figure 7 assumes that buyers spend 20 minutes longer at slow-service stores that at fast-service stores. Suppose that slow stores improve their service so that now buyers must spend only 10 minutes longer at those stores. Show on the graph how this change affect the equilibrium in Figure 7.

The improvement in service at slow stores will cause some people to switch from the more expensive but faster stores to the cheaper but slower stores (because the slower stores became less slow than before).  As a result, demand at fast stores falls and demand at slow stores rises, reducing equilibrium prices and output at the fast stores, and raising equilibrium prices and output at the slow stores.
 

15. Draw a graph to show the effects on money prices and quantities sold when:
a. Social pressure to buy a good (such as a certain kind of sneakers) increases
b. Social pressure to sell a good (such as an environmentally friendly soap) increases

(a) Demand for the good (such as the sneakers) rises, raising the price and the quantity bought and sold.
(b) Supply of the good (such as the new soap) rises, lowering the price and increasing the quantity bought and sold.
 

16. Police officers in a major city obtain one-third of their income in the form of bribes until the government begins strict enforcement of anti-bribery laws.  How does this new government policy affect the equilibrium salaries of police officers?

The opportunity to collect bribes is a partial substitute for formal wage payments. Thus, a decrease in expected bribes lower the supply of police officers. This decrease in the supply of labor increases the formal wage of police officers..
 

17. A dishonest university president plans to grant one pizza vendor the right to sell pizzas in the new student activity building.  Many pizza vendors have offered bribes to the president in return for that right.  What will determine the equilibrium size of the winning bribe?

Each pizza vendor who wants the right to sell in the new student activities building will be willing to offer any amount up to the level of the profits which that vendor could earn if it got the right to sell pizzas there.  If any pizza vendor would earn the same level of profits by selling at the university, then the winning bribe will equal that level of profits.  (If any pizza vendor offered a lower bribe, then some other pizza vendor would be willing to out-bribe it.)  If some pizza vendors would earn higher profits than others by selling at the university, then the pizza vendor who would earn the highest profit there would be willing to offer the highest bribe.  That pizza vendor would only have to offer a bribe that is a little bit higher than the highest bribe that it thinks any other pizza vendor would offer.  So the winning bribe will be just slightly more than the profit that would be earned by the second-most-profitable pizza vendor.

18. Suppose that someone who works for a government regulatory agency for several years can expect to get a lucrative consulting job in later years with the industry that the agency regulates. How does this affect the supply of people to government regulatory jobs?

It raises the supply of people to jobs in government regulation.

19. Some sports stars earn extra income by making television commercials. Explain how this opportunity affects average salaries in sports.

The extra income opportunities have effects similar to the effects of bribes -- these opportunities for extra income raise supply of people seeking to be sports stars, and reduces their sports salaries (not including commercials, etc.).

20. (a) Suppose that the government removes legal prohibitions against buying some good, so the expected-punishment price falls from $100 to zero. Show (on a graph) how this change affects the money price of the good and its quantity sold.

If the expected-punishment price falls by $100, the demand curve shifts upward by $100. When the expected-punishment price is $100, the demand curve is D1.  When the expected-punishment price falls to zero, the demand curve rises to D2.  As a result, the money price of the good rises by less than $100 and the quantity sold increases.

(b) Suppose that the government removes legal prohibitions against selling some good. Draw a graph to show the effects of legalizing the good on its money price and quantity sold.

In this case, supply increases as the supply curve shifts downward (vertically) by the fall in the expected-punishment price.  Output of the good rises and the money price of the good falls, though the money price falls by less than the expected-punishment price.
 

21. Discussion on a television talk show makes people worry about getting mad-cow disease if they eat beef. Explain how this can affect the price of beef. Does the effect depend on whether the risk is real or imagined?

It reduces demand for beef, and therefore reduces the price.  The effect does not depend on whether the risk is real or imaginary.
 

24. Airline travel would be safer if pilots had more training and more rest between flights, if planes were inspected more often and more thoroughly, and if older planes were scrapped. Each of these changes has a cost. How should people compare these costs with the additional safety that they would buy? How much training and rest should pilots get? How often and how thoroughly should planes be inspected? Could any general principles guide these decisions?

HERE IS ONE POSSIBLE ANSWER -- YOUR ANSWER MAY BE DIFFERENT.  In making these types of decisions, airlines should compare the costs with the benefits. At some point the added safety from additional hour of training, rest, or inspection becomes negligible, or requires added costs that people are not willing to pay to fly on that airline.  If people always had choices of different airlines to fly, then each airline might have incentives to make their flights safer if customers are willing to pay enough more for the additional safety to cover the airline’s costs of that additional safety.  Then airlines would make their choices about safety based on the amount of safety that their customers are willing to pay for.  (If one airline were safer than another, and the value to customers of the additional safety exceeded the difference in air fares, people would choose the safer airline.  If customers did not consider the additional safety worth the extra air fares, they would fly the less-safe but cheaper airline.)  Problems might arise when customers live in cities without much competition among airlines, or when customers don’t know how safe an airline really is, or much safer some airlines are than others.
 

25. Suppose that people's tastes change and they want to switch from stressful to peaceful jobs. Draw graphs to show this increase in demand for a peaceful job affects wages in stressful jobs and peaceful jobs.

This change in tastes increases the supply of labor for peaceful jobs and decreases supply of labor to stressful jobs.  These changes reduce wages for peaceful jobs and raise wages for stressful jobs.
 

26. Alan Dershowitz, a Harvard law professor, has argued that parents in some countries choose abortions or even infanticide for female babies because they prefer male babies due to tradition and to the high cost of dowries. His argument goes on, "if this is allowed to continue and expand, it could affect the natural balance between males and females. Throughout history, of course, there have been other factors that have skewed the proportion of males and females: wars, certain sex-linked illnesses, even crime." Use supply-and-demand analysis to discuss the effect on the size of dowries if the number of females per males in the society were to decrease.

A dowry is a price that the male (or the male’s family) receives from the female (or female’s family) upon marriage.  Economically, we can think of the dowry as a price of the male’s marriage service.  With fewer females, the demand for males’ marriage services decreases, lowering the price (the dowry).  Similarly, an increase in the number of males would mean an increase in supply of males’ marriage services, also reducing the price (the dowry).
 

27. Some people claim that you cannot buy friends. Can you? What kind of non-money prices would you pay? What factors affect your demand for friends?

HERE IS ONE POSSIBLE ANSWER -- YOUR ANSWER MAY BE DIFFERENT.  While you cannot buy true friends with money, you can "buy" them with such things as time, kindness, honesty, and other investments in relationships with friends. The non-money prices that people would be willing to pay depend on how much they want friends and how much they enjoy (or dislike) spending time alone. A person’s demand for friends would depend on such factors such as the number of other friends the person has, the amount of free time the person has available, and personality.
 

29. Why does it take time (in some cases) for prices to adjust to new equilibrium levels after changes in demand?

It can take time for a seller to recognize a surplus or shortage of a good at the current price. Even then, it may take time to change price tags or prices in catalogs.
 

30. Do goods that last twice as long, or are twice as big, cost twice as much? Explain why or why not.

Not necessarily. In some cases, buyers might not be willing to pay twice as much for a good that lasts twice as long, because it may go out of style (for example, clothing), or be replaced by higher-quality models in the future (for example, computers).  Similarly, buyers might not want products that are twice as big!  (Think of clothing again.) In these cases, buyers might be willing to pay only a little more (or perhaps unwilling to pay as much) for a good that lasts twice as long or is twice as big.  In other cases, buyers might be willing to pay more than twice as much for a good that lasts twice as long (for example, to avoid the inconvenience of having to buy it again soon) or is twice as big (for example, you might be willing to pay more than twice as much for a television with twice as big a screen).  These factors affect demands.   Other factors affect supplies.  For example, it may cost 3 times as much to produce a good that would last twice as long, so sellers would be willing to produce and sell it only if they could get 3 times the price.  While goods that last longer often cost more, there is no simple relation between how long they last, or their sizes, and their prices.

31. You can buy fame! Many colleges will name a building, classroom, or professorship after you for a price. Hospitals will name an operating room or patient's room after you. Sports facilities, gardens, and even seats at performing-arts centers have names for sale. What determines their prices?

The demand depends partly on peoples’ tastes for fame, and how famous they think they will become if some facility is named after them. The demand also depends on the extent to which some people are altruistic and prefer to donate money for these facilities anonymously or without getting the recognition of a named facility.  The supply of facilities looking for names depends on the extent to which colleges, hospitals, performing arts centers, etc., are willing to name or rename facilities in return for donations.  Part of that decision may involve a feeling that providing named facilities to some donors might reduce normal donations (that do not provide a named facility to the donor).  The decision may also involve a calculation that the institution could generate an even larger donation by waiting until a future date to sell the name of a facility.  The combination of these forces of demand and supply determine  prices.
 

32. Extend your imagination and develop supply-and demand-analysis to predict the economic effects --- the effects on the prices and quantities of various goods --- of the following changes.

HERE ARE SOME POSSIBLE ANSWERS -- YOUR ANSWERS MAY BE DIFFERENT.

a. The spread of AIDS.

Demands would increase for condoms, hospitals and various health services, rubber gloves, and for medical research to alleviate effects of AIDS or to cure it.  This would raise prices for these products and services. The spread of AIDS raises the cost of sexual promiscuity, so the demand for abstinence or safe sex would rise.  Demand would increase for services or new products to help screen blood before transfusions. The average age of marriage might fall,

b. Sudden global warming.

c. An increase in the average age of marriage.

Demand for one-bedroom apartments would increase, boosting rental rates.  If this also raised the average age at which people have children, it would temporarily reduce the demand for child-related products (as people postpone child-bearing) such as cribs, strollers, and children’s’ clothing.  The demand for singles-related activities (such as vacations organized for singles) would increase.

d. An increase in the fraction of the population over age 65.

Demand for nursing homes, retirement communities and medical care would increase, raising the prices and quantities produced of these goods.

e. A new baby boom.

Demand for diapers, baby food, and all other manner of baby goods would increase, pushing up the prices of these goods and the quantities produced.

f. A technological breakthrough that makes solar energy almost free
 

g. A worldwide ban on products that harm the ozone layers.

Demand for environmentally safe products would increase, raising the prices of these products and increasing the quantities produced. Demand for harmful products would fall, reducing their prices and the quantities produced.

h. A microelectronics revolution that makes supercomputers as cheap as shoes.

This increase in the supply of supercomputers would reduce the costs of producing many new kinds of electronic goods and “smart” products (such as cars that drive themselves to a programmed destination, watching out for traffic and other obstacles along the way), raising the supplies of such products and lowering their prices.  (Some of these products would be entirely new.)  These changes would have further effects.  Cheap and effective computer voice-recognition products would reduce the demand for keyboards and computer mice; the demand for professors would be reduced by computers that could give lectures, answer questions, grade exams, lead discussions, and recognize what kinds of mistakes students make on exams and inform them of their errors and how to correct them.

i. A major, conventional war in some part of the world.

The demand for armaments and other war-related products would increase, raising their prices.  Supplies of some products might be disrupted by the war, raising prices of those products.  The war might increase world demand for health-care services and products, raising their prices.

j. A sudden and massive decrease in the demand for drugs.

The price of drugs would fall along with the equilibrium quantity purchased.  Drug dealers would go out of business and have to find other sources of income.  The demand for police services to fight a war on drugs would decrease, raising the number of police available to perform other tasks, such as pursuing robbers or people who speed on highways.  That change in the allocation of police might reduce the demand for security systems on houses and automobiles, and raise the demand for radar detectors as some people seek to avoid being caught speeding.
 

33. Single men in their twenties outnumber single women in their twenties in the United States by about a six-to-five ratio. (For every five women, there are six men.) A generation ago, the numbers were more equal. The ratio of men to women also varies across cities in the United States. What do you think are the results of the increase in the supply of men relative to the supply of women? What do you think are the effects of differences across cities? How might the economics of supply and demand apply to this situation?

HERE IS ONE POSSIBLE ANSWER -- YOUR ANSWER MAY BE DIFFERENT.  An increase in the supply of men relative to women gives women more options in choosing men as friends, romantic partners, or husbands.  The increase in supply raises the amount of competition (for women) that each man faces.  One likely result of this additional competition would be that women find more satisfactory matches than they otherwise would.   Another likely result is that men try harder to undertake actions that increase their chances of successful matches with women, while women (who have a larger set of opportunities to choose from) put less effort into finding matches than they would otherwise.

34. Should the government limit the extent to which sellers profit from the misfortune of others?

a. If not, explain why not, then answer the following questions. Suppose that a woman sees a man about to drown. She yells to the drowning man, "I will save you if you give me your life savings!" The man yells "Okay, I promise!" and she saves him. Should the courts enforce his promise, or should the government limit profits made in this way from the misfortunes of others? Under what conditions, if any, should the government limit profits made from the misfortunes of others?

HERE IS ONE POSSIBLE ANSWER -- YOUR ANSWER MAY BE DIFFERENT.  No, the government should not limit the extent to which sellers profit from the misfortune of others in some cases.  The ability to profit from helping someone else provides a strong incentive to help others, and to invest in whatever equipment and supplies are needed to provide help to others.  This ability to profit from the needs of others -- for food to prevent hunger, auto repairs following traffic accidents, medical services when a person gets sick or injured, and so on -- drives most of our economy.  It would be ludicrous to prevent people from profiting from the needs, wants, or misfortunes of others.  The example of the drowning person is an extreme example.  Although it may seem unfair to enforce the promise, it is better to enforce the promise to pay than to limit the extent to which people help others by not enforcing it.

b. If so, how? Does your argument suggest that the government should limit the incomes doctors earn by treating patients? Should it limit the gains of farmers from selling food to people who have the misfortune to be hungry? Doesn't a plumber gain from a person's misfortune to have clogged pipes? Doesn't every seller gain from the misfortune of buyers? How would you choose which gains to limit and which not to limit? What is your general principle for deciding?

HERE IS ANOTHER POSSIBLE ANSWER -- YOUR ANSWER MAY BE DIFFERENT. Yes, the government should limit the extent to which sellers profit from the misfortunes of others, but only in some cases.  Consider the example of the drowning person.  Enforcing promises like this (to pay his life’s savings) would discourage people from helping others out of feelings of responsibility or altruism.  It would encourage people to bargain for some kind of payment whenever they help someone.  This would add to a victim’s problems (for example, not only would a person nearly drown, but also end up paying his life savings to be rescued).  People don’t want to live in a society that makes their problems even worse in such cases, so courts should not enforce such promises.
 Of course, every time an automobile body shop repairs a car, that shop benefits from the fact that the car owner had some misfortune with the car.  And courts should require people to keep their promises to pay for repairs done on their cars.  The same is true with food sales, plumbing repairs, and so on.  In all these examples, one person benefits from the misfortunes of another. The difference between these cases and the drowning case lies mainly in the fact that the person having a car repaired could have gone to someone else for repairs if the body shop required a price that the person felt was too high.  The same is true for food sales, plumbing work, and so on.  In contrast, the drowning person had little choice but to accept the first offer of help.  Generally, I think people should be required to honor their promises to pay except when those promises were made in emergencies -- when they had no reasonable opportunity to consider any other offers from other would-be helpers -- or when it is clear that not honoring those promises to pay would have a big effect on limiting help to victims in future emergencies.
 

35. It is possible to buy the right to immigrate to some countries; sometimes it is possible to buy citizenship in those countries. (Some of this trade is illegal.) What determines the price of immigration rights? Do you think that the United States should sell rights to immigrate to the highest bidders?

HERE IS ONE POSSIBLE ANSWER -- YOUR ANSWER MAY BE DIFFERENT.  The price of immigration rights is determined by the demand for citizenship in a particular country and the supply of immigration spots available. If citizenship had a price (and it does in some countries), it would be high in a country like the United States where the quality of life is relatively good, and lower in countries with lower incomes, fewer opportunities, or less desirable conditions (due to wars or to bad pollution problems).  Perhaps the United States should sell immigration rights to the highest bidders because the people who would be willing to pay the most might tend to be the people who can make the most of their opportunities in the U.S.  Or perhaps the United States should not sell immigration rights to the highest bidders because this would not attract the kinds of people that we want to have immigrating to the U.S.
 

36. Do you think that the demand for democracy and freedom rises when people become richer? Does freedom ever have a price? Does democracy? For example, do countries ever sacrifice national security for freedom or democracy? (Perhaps national security could be improved by higher taxes to spend on defense, or by a military draft, or by permitting the police to search houses without search warrants.) Do countries ever sacrifice traditional cultures for freedom or democracy? What affects the demand for freedom? The demand for democracy?

HERE IS ONE POSSIBLE ANSWER -- YOUR ANSWER MAY BE DIFFERENT.  People who are mainly concerned about their family’s next meal may be too busy struggling to survive to care as much about democracy and freedom as people who are wealthier.  On the other hand, freedom and democracy might be more important to people who live in such dire circumstances.  (A person might want the freedom to sell crops that she grows and use the money to buy food and clothing for her family, for example.)  Around the world, richer countries appear more likely than poorer countries to have democratic governments and to offer freedom.  This may result from a higher demand for freedom and democracy by people in richer countries.  Or it may result from the ability of freedom and democratic government to create wealthy societies.  It is not clear which causes which.
        Freedom and democracy definitely have a price, as those who have fought in wars to preserve our rights well know. Obviously, national security can conflict with freedom -- for example, giving police the right to search anyone without a warrant would probably raise national security but would certainly reduce freedom.  So lower national security is part of the price we pay for freedom.  Similarly, some countries sacrifice traditional cultures to allow their citizens greater freedom (or sacrifice freedom for the sake of traditional cultures) -- for example, some countries limit access to U.S. television shows, or have laws that limit use of the English language, all in the name of traditional culture.