Written Assignment 1

1. What is the mechanism by which the "invisible hand" pushes markets to

equilibrium?

Adam Smith pioneered the concept of the “invisible hand”, which allows households
and firms to interact and compete with one another. The invisible hand is based on
Smith’s belief that consumers will always want the best price, and the producers will
always want to maximize profit. Basically, if the government would not interfere in
what consumers could buy and what producers could produce, and both buyers and
sellers were free to make their own choices, then market prices would be beneficial
for both consumers and producers (Mankiw 2008). The mechanism of the invisible
hand says that producers will try to maximize profits by working more efficiently to
maximize production while doing so at the lowest possible price to eliminate
competition- in turn other producers will do the same and the consumer is free to
choose the lowest priced producer. The push of the invisible hand will result in an
increase in financial gain because the consumer is getting a competitive price for high
quality goods or services and the seller is increasing sales profits.

2. Use a production possibilities frontier to describe efficiency. (This question

can be answered either with or without the use of a graph, depending on
whether you have a graphing program on your computer. It is possible to
describe the various points on the PPF without a graph.)
 Production possibility curve of Guns and Flowers in the
12
United States

10

A
D
Guns Per Million Produced

6 B
E C
4

0
0 2 4 6 8 10 12 14 16 18 20
Flowers per Million Produced

A PPF predicts that all resources are used effectively. This PPF demonstrates how many
guns and flowers the United States can produce maximizing all of their resources and
technology.

Here are the numbers that I used:

United States

Guns Flowers
(In Millions)
X Y
18 1.0
12 6.0
1 10.0

As you can see point A, B, and C show at which production rate these goods can be
produced more efficiently. Point D shows a production output that is not realistic using the
current resources (because it lays outside of the PPF curve) and point E shows an output not
utilizing all of the resources available ((because it lays below the production possibility
frontier). (I graphed this using Excel, I hope it shows up clearly when I merged it into the
Word Document).

3. What is the difference between a positive and a normative statement? Give

an example of each.

A Positive statement is fact based and normative statements are opinion based.

Positive statement: The unemployment rate in the State of Florida has risen 10%
since last year. (Fact)

Normative Statement: Miami-Dade County should increase its school funding in every
district. (Opinion)

The positive statement above can be verified, if need be. Whereas, also my
normative statement includes a fact (funding for school districts has decreased over
the last 2 years), BUT it is only my OPINION that the county should fun the school
districts.

4. Explain how absolute advantage differs from comparative advantage.

Absolute advantage is when a person/country/entity/actor can produce a service or

good at a lower price, using fewer resources than their competitor. Comparative
advantage is when a person/country/entity/actor can produce a service or good at a
lower opportunity cost than their competitor. Absolute advantage is based on actual
cost, whereas comparative advantage is based on opportunity cost or how much you
give up producing the other. The entity that “gives up” less has the comparative
advantage. Comparative advantage is based on the theory that trading one good you
produce at an absolute advantage with one that the entity does NOT produce at an
absolute advantage.

5. What are the factors that determine the quantity of a good that buyers
demand?

There are several factors that determine the quantity of a good demanded, these
include:

Price of good--if the prices of a good or service rises people buy less. The quantity
demanded of a product is negatively related to its price- as prices rise; the demand
decreases and demand increases when prices decrease. Income--If a person’s
income decreases then they have less income to spend on goods or services and
their demand falls. Expectations--If today you are earning a higher wage than your
neighbor, you may be more incline to spend money and thus demand goods/services.
But if you think you might be laid-off from work for example, or you just found out your
company is closing in the next few months you may be inclined to spend less,
decreasing your demand for goods and services. Personal Tastes, as with the
example above, even if the price of gold rises very high, but you love gold and you
collect it, as an example- you will still buy gold- even at an extraordinary price. This is
why economist don’t try to explain peoples tastes because there are human
psychological factors that play a role outside the scope of study of economics.
Number of buyers—the more people desire to buy gold- the higher its demand will
be.

6. Define the equilibrium of a market. Describe the forces that move a market
toward its equilibrium.

A market equilibrium is when the price of a good or service levels out when the
quantity demanded is the same as the quantity supplied. Just like the Frisbee
example. If there is a shortage or surplus, then the market is out of equilibrium.
The invisible hand or the actions of consumers and producers naturally moves
the markets towards equilibrium

If there is a shortage, meaning the quantity demanded cannot be fulfilled to the

consumer with the quantity supplied prices will rise for the item or good.

If there is a surplus, or there is more supply than demand- then the price for the
good or service will fall.

In the free market that we enjoy in the U.S., when the market is out of equilibrium
it is usually only temporary because the supply and demand will eventually even
out once again and market equilibrium will be established.

7. List and explain the four determinants of price elasticity of demand, discussed in
chapter 5.

1. Availability of substitutes of a good--For example, when candle

prices increase from a particular merchant, close substitute candles
from another merchant at lower prices causes the higher price candle
demand to decrease and the substitute candles, whose prices remained
fixed and lower than their competitors to rise.
2. Necessities vs. Luxuries--When the price of baby formula rises, most
people will not decrease their demand for it as it is a necessity for
babies, but when the prices of gold rise there will be a decrease in
demand as this item is considered a luxury by most. Necessities and