CHAPTER 14 Free Markets; Price System
Test Yourself
1. (a) If there is enough electrical generating capacity to run all the air conditioners on very hot days, much of that capacity will be idle, and therefore wasted, on most days. Charging higher prices on the hot days will restrict usage at those times and therefore reduce the power generating capacity that must be built. The resources saved can be used for something else.
(b) In a drought-stricken area, there has to be a way to reduce water usage; otherwise, the society will simply run out and not have water for its most critical, life-saving uses. Raising the price of water can accomplish this, by inducing people to use water only for high-priority purposes.
Discussion Questions
1. Both proposals may be unfair to the poor, because they have less discretionary income and may have to cut back their usage more than others do. Other groups who may be unfairly harmed are those who use large quantities of electricity or water and have difficulty cutting back. Students should understand that it is difficult for an economist to deal with questions of fairness because, while there are objective criteria for efficiency, there are only subjective criteria for fairness. The best one can do is to be explicit about those criteria.
2. (a) Both tea lovers and coffee lovers could be made better off, and no one would be worse off, if the tea lovers swapped coffee for tea with the coffee lovers. Therefore the current situation (without the swaps) is inefficient.
(b) The situation is inefficient because both ditch digging and car repair are being badly done. If the jobs were switched, both would be well done.
(c) There are more trucks and fewer cars than people would prefer. With the same resources, the community could get more cars (which they want) by giving up trucks that they do not want.
3. (a) If the government regulates output quantities, it may decree quantities that differ from the community’s preferences, for example, too many trucks and not enough cars.
(b) If commodities are rationed, the quantities that people are allowed to buy may have nothing to do with their preferences; for example, tea lovers may lack tea and have more coffee than they want, and vice versa for coffee lovers.
(c) If soldiers are assigned to different jobs in the army, those jobs may have nothing to do with their aptitudes: skilled mechanics may be assigned to dig ditches, and people with strong backs but no skills may be assigned to repair machines.
4. Question 2(a) is a case of the inefficient distribution of product. Question 2(b) is a case of inefficient production planning. Question 3(c) is a case of inefficient output selection.
5. (a) In a free market, people can buy as much of different goods as they want, given their budget. Tea lovers can buy more tea, coffee lovers more coffee.
(b) In a free market, a firm that hired skilled workers to do unskilled work would go out of business, because a competitor would hire unskilled labor at a lower wage to do the same job, and be able to sell its products at a lower price.
(c) In a free market, if there was an excess supply of trucks and an excess demand for cars, the price of the former would fall and the price of the latter would rise. This would lead producers to switch toward car production, and it would lead consumers to switch toward truck purchases.