Chapter 14/The Case for Free Markets: The Price System
CHAPTER 14
THE CASE FOR FREE MARKETS: THE PRICE
SYSTEM
TEST YOURSELF
1. What possible social advantages of price increases arise in the following cases?
a. Charging higher prices for electrical power on very hot days when many people
use air conditioners
b. Raising water prices in drought-stricken areas
(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
2. In the discussion of Figure 3, there is a set of numbers indicating how much different
buyers would be willing to pay for a book. Construct a table for these buyers like the
first three columns in Table 1, indicating their consumer surpluses.
3. As in the previous question, use the numbers in Figure 3 to determine the producer’s
surpluses and complete your table to correspond to the remaining columns of Table 1.
Solutions for 2. and 3.
Buyers
Buyers
Acceptable
Price
Individual
Buyers
Surplus
Actual
Price
Cumulative
Total Surplus
Individual
Firm’s
Surplus
Firms
Acceptable
Price Firms
1 70 30 40 $60=30+30 30 10 1
2 60 20 40 100=60+20+20 20 20 2
DISCUSSION QUESTIONS
1. Discuss the fairness of the two proposals included in Test Yourself Question 1.
Chapter 14/The Case for Free Markets: The Price System
Both proposals may be unfair to the poor, because they have less discretionary income
2.Using the concepts of marginal cost (MC) and marginal utility (MU), discuss the nature
of the inefficiency in each of the following cases:
a. An arrangement that offers relatively little coffee and much tea to people who
prefer coffee and does the reverse for tea lovers
b. An arrangement in which skilled mechanics are assigned to ditch digging and
unskilled laborers to repairing cars
c. An arrangement that produces a large quantity of trucks and few cars, assuming
that both cost about the same amount to produce and to run but that most people
in the community prefer cars to trucks
(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
3. In reality, which of the following circumstances might give rise to each of the
situations described in Discussion Question 2?
a. Regulation of output quantities by a government
b. Rationing of commodities
c. Assignment of soldiers to different jobs in an army
(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.
4. We have said that the economy’s three coordination tasks are output selection,
production planning, and product distribution. Which of these is done badly in the
cases described in Discussion Questions 2a, 2b, and 2c?
Question 2(a) is a case of the inefficient distribution of product. Question 2(b) is a case of
5.In a free market, how will the price mechanism deal with each of the inefficiencies
described in Discussion Question 2?
(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.
6. China’s transition to a market economy is arguably the greatest modern economic
success story. What sorts of policies have made China’s incredible economic growth
possible? How have China’s citizens benefited from this growth? What additional
reforms are needed if China is to sustain its strong economic growth well into the
future?
Economic reforms, combined with China’s opening to international trade and investment
in the 1980s, spurred China’s initial economic development. Then, in the 1990s, new
reforms that allowed private and state-owned enterprises to compete as equals in the