1. THE ECONOMY: THE CORE PROJECT

2. UNIT 11. MARKET DYNAMICS

3. T11.1 Friedrich Hayek
Which of the following statements is correct? According to Friedrich Hayek:
Select one answer
Prices convey the scarcity of a good under a centrally planned economy.
Perfect competition can be attained without activities such as advertising, undercutting, and improving ("differentiating") the goods or services produced.
The advantage of capitalism is that it provides the right information to the right people.
A single central authority can collate and make use of the information available in the economy better than the market.
Section 11.0

4. ANSWER: T11.1 Friedrich Hayek
Which of the following statements is correct? According to Friedrich Hayek:
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For prices to convey information regarding scarcity of goods, they need to be free to move according to supply and demand.
Perfect competition needs activities such as advertising, undercutting, and improving (“differentiating”) the goods or services produced for it to be attained. The problem for Hayek was that, by definition, “perfect” competition assumes absence of these activities.
Hayek believed that capitalism made fuller use of existing information compared to central planning.
Hayek questioned, “whether we are more likely to succeed in putting at the disposal of a single central authority all the knowledge which ought to be used but which is initially dispersed among many different individuals, or in conveying to the individuals such additional information as they need in order to enable them to fit their plans in with those of others.” He advocated the latter.
Select one answer
Prices convey the scarcity of a good under a centrally planned economy.
Perfect competition can be attained without activities such as advertising, undercutting, and improving ("differentiating") the goods or services produced.
The advantage of capitalism is that it provides the right information to the right people.
A single central authority can collate and make use of the information available in the economy better than the market.
Section 11.0

5. T11.2 Reaching a new equilibrium
The following diagram depicts the competitive market for hats before and after a demand shift. Based on this information, which of the following statements is correct?
Select one answer
After the demand shift, the market initially moves from A to E, before settling to the new equilibrium at F.
At E, the sellers are on the short side of the market.
At E, lowering the price to $7 results in a Nash equilibrium for the buyers and sellers.
In the adjustment process from E to the new market equilibrium F, the sellers behave as price-makers while the buyers remain price-takers.
Section 11.1

6. ANSWER: T11.2 Reaching a new equilibrium
The following diagram depicts the competitive market for hats before and after a demand shift. Based on this information, which of the following statements is correct?
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Holding prices unchanged, the fall in demand leads to excess supply. As a result of rent-seeking behaviour among buyers and sellers, the price adjusts until all rent-seeking behaviour is eliminated (point F).
At E there is an excess supply of hats. Therefore the buyers are on the short side of the market.
If the price is lowered to $7 then there will still be an excess supply of hats. Then the buyers can do better by offering to pay less than $7, while the sellers can do better by selling the excess hats at a price lower than $7. Therefore trading at $7 is not a Nash equilibrium.
Both sellers and buyers behave as price-makers, leading to voluntary trades on the short side of the market. The price would then fluctuate both above and below $6, before eventually settling at F.
Select one answer
After the demand shift, the market initially moves from A to E, before settling to the new equilibrium at F.
At E, the sellers are on the short side of the market.
At E, lowering the price to $7 results in a Nash equilibrium for the buyers and sellers.
In the adjustment process from E to the new market equilibrium F, the sellers behave as price-makers while the buyers remain price-takers.
Section 11.1

7. T11.3 Short-run and long-run equilibrium
In the market for a particular identical good there are initially a large number of each of two types of producers: Type A and Type B. Type A producers use a better production technology than Type B producers, so Type A's average cost curve is lower than Type B’s. Both types have upward-sloping marginal cost curves and U-shaped average cost curves. Which of the following statements is correct regarding the short-run and the long-run equilibria of this market?
Select one answer
In the short-run equilibrium, Type B firms produce where the price equals their marginal cost (MC), while Type A firms produce where the price is above its MC.
In the long-run equilibrium, both Type A and Type B firms produce where the price equals their average cost (AC).
Type A firms all produce more in the long-run equilibrium than in the short-run equilibrium.
In the long-run equilibrium, MC = AC for Type A firms so their economic profits are zero.
Section 11.3

8. ANSWER: T11.3 Short-run and long-run equilibrium
In the market for a particular identical good there are initially a large number of each of two types of producers: Type A and Type B. Type A producers use a better production technology than Type B producers, so Type A's average cost curve is lower than Type B’s. Both types have upward-sloping marginal cost curves and U-shaped average cost curves. Which of the following statements is correct regarding the short-run and the long-run equilibria of this market?
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At all equilibria, all firms produce where price equals their marginal cost. This is the firm’s supply curve.
In the long-run equilibrium, there are no Type B firms because Type A firms have entered driving down the price to the minimum of the Type A firms’ average cost curve.
At the higher price when the Type B firms were in the market, Type A firms were equating price to marginal cost at a point to the right of the minimum of the AC curve. In the long run equilibrium all Type A firms produce at the minimum of their AC curve, which is at a lower level.
In the long-run equilibrium, there are no Type B firms and Type A firms will continue entering until the price falls to the minimum point on the AC curve where MC-AC and because P=MC=AC, there are no economic profits.
Select the correct answer(s).
In the short-run equilibrium, Type B firms produce where the price equals their marginal cost (MC), while Type A firms produce where the price is above its MC.
In the long-run equilibrium, both Type A and Type B firms produce at where the price equals their average cost (AC).
Type A firms all produce more in the long-run equilibrium than in the short-run equilibrium.
In the long-run equilibrium, MC = AC for Type A firms so their economic profits are zero.
Section 11.3

9. T11.4 A continuous double auction book
The following is an order book for News Corp shares. Consider the case where there is a limit buy order for 650 shares at $16.59, followed by a limit sell order for 600 shares at $ Based on this information, which of the following statements is correct?
Select one answer
After the initial limit buy order, there will be 150 shares at $16.59 on the bid side of the order book.
The subsequent limit sell order will be filled with 400 shares at $16.56 and 200 shares at $16.55.
After the two trades, the first buyer will have bought 500 shares at $16.59 and the remaining 150 shares at $16.55.
The last traded price would be $16.56.
Section 11.6

10. ANSWER: T11.4 A continuous double auction book
The following is an order book for News Corp shares. Consider the case where there is a limit buy order for 650 shares at $16.59, followed by a limit sell order for 600 shares at $ Based on this information, which of the following statements is correct?
Select one answer
After the initial limit buy order, there will be 150 shares at $16.59 on the bid side of the order book.
The subsequent limit sell order will be filled with 400 shares at $16.56 and 200 shares at $16.55.
After the two trades, the first buyer will have bought 500 shares at $16.59 and the remaining 150 shares at $16.55.
The last traded price would be $16.56.
Feedback
There are only 500 shares available to be sold for $16.59, so the remaining 150 shares will remain on the buy side at $16.59.
After the first limit buy order, there are 150 shares remaining on the bid side of the order book at $ With the subsequent limit sell order, these will be traded first. Of the remaining 450 shares, 400 will be sold at $16.56 and 50 will be sold at $16.55.
After the two trades, the first buyer will have bought all 650 shares at $16.59.
The last traded price is $16.55.
Section 11.6

11. T11.5 Bubbles
Which of the following statements regarding asset price bubbles is correct?
Select one answer
Some economists believe that bubbles do not exist.
According to the efficient market hypothesis, bubbles occur when the market misprices the value of an asset.
The market can easily know that it is in a bubble by comparing the market price with the fundamental value of the asset.
For a bubble to occur, market participants must disagree about the fundamental value of the asset.
Section 11.7

12. ANSWER: T11.5 Bubbles
Which of the following statements regarding asset price bubbles is correct?
Select one answer
Some economists believe that bubbles do not exist.
According to the efficient market hypothesis, bubbles occur when the market misprices the value of an asset.
The market can easily know that it is in a bubble by comparing the market price with the fundamental value of the asset.
For a bubble to occur, market participants must disagree about the fundamental value of the asset.
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Some economists believe in the efficient market hypothesis, which rules out the existence of bubbles.
The efficient market hypothesis states that all generally available information about the fundamental value is instantaneously incorporated in the market price. Therefore according to the efficient market hypothesis, bubbles cannot happen.
If the market knew that it was in a bubble, the investors would immediately sell the asset. Bubbles are hard to spot while they are growing, which allows them to keep growing.
Market participants do not need to agree about the fundamental value of the asset for a bubble to form. The bubble forms when the market price deviates substantially from these estimated fundamental values.
Section 11.7

13. T11.6 A price floor (minimum wage)
The UK introduced a national minimum wage in Which of the following statements regarding minimum wages is correct?
Select one answer
A minimum wage is a form of price ceiling.
The introduction of a minimum wage would always lead to a fall in the demand for labour by firms.
A minimum wage would not lead to increased unemployment if it is set low enough.
Instead of a minimum wage, the government can promote increased labour participation to encourage higher wages.
Section 11.10

14. ANSWER: T11.6 A price floor (minimum wage)
The UK introduced a national minimum wage in Which of the following statements regarding minimum wages is correct?
Select one answer
A minimum wage is a form of price ceiling.
The introduction of a minimum wage would always lead to a fall in the demand for labour by firms.
A minimum wage would not lead to increased unemployment if it is set low enough.
Instead of a minimum wage, the government can promote increased labour participation to encourage higher wages.
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Minimum wage is a form of price floor since it places a lower limit on the amount a worker can be paid.
It depends on whether the minimum wage is higher or lower than the equilibrium wage level. Introducing a minimum wage would lead to a fall in the labour demand only if it is set at a level higher than the equilibrium wage level.
If the minimum wage introduced is below the equilibrium wage level, labour demand and unemployment will not change.
To achieve a higher wage level as a market equilibrium, the government should encourage higher demand for labour and not higher supply (the latter would result in a lower equilibrium wage level).
Section 11.10