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Chapter 7
Perfect Competition and the Invisible
Hand
Questions
1. All else equal, does a steep or flat demand curve result in higher social surplus? How does steepness
of supply affect social surplus?
Answer: Everything else equal, a steep demand curve will result in higher social surplus. As can be
seen in the following figures, social surplus (shown by the triangles A and B) is higher in the market
with a steep demand curve.

Similarly, other things remaining the same, social surplus (shown by the triangles A and B) is higher
in a market with a steeper supply curve.

© 2015 Pearson Education, Inc.

 Chapter 7 | Perfect Competition and the Invisible Hand 70

2. How do economic profits and losses allocate resources in an economy?

Answer: When positive economic profits exist in an industry, resources flow to that industry because
of the profits available. This behavior causes resources to flow from less productive uses to more
productive uses. That is, businesses seek to improve their profits and in so doing, they move
resources into the production of goods and services that society values the highest. Similarly, when
firms face economic losses, they exit the industry and put their resources to more profitable uses.
Again, this allocates resources to industries that produce goods and services that society values the
highest.
3. How will the invisible hand move corn prices in response to:
a. a flood that destroys a great deal of the corn crop?
b. a rise in the price of wheat (a substitute for corn)?
c. a change in consumer tastes away from corn dogs toward hot dogs?
d. an increase in the number of people with access to the corn market?
Answer:
a. Since a great deal of the corn crop has been destroyed by the flood, the supply curve for corn
will shift leftwards and the price of corn will increase.
b. When the price of a substitute such as wheat increases, the demand for corn will increase.
The demand curve will shift rightwards and the price of corn will increase.
c. Corn (not surprisingly) is an important input in the production of corn dogs. If consumers
prefer fewer corn dogs, the demand curve for corn will shift leftwards and the price of corn
will fall.
d. As more buyers enter the market, the demand for corn will increase. The demand curve will
shift rightwards and the price of corn will increase.
4. Hardware stores charge higher prices for snow shovels after a big snowstorm. What role do prices
play in the snow shovel market?
Answer: Prices allocate scarce resources (such as snow shovels after a big snow storm) to the
consumers who value snow shovels the highest. Thus prices play an important role in the
maximization of social surplus. Prices in this case will also increase producer surplus (i.e, the
hardware stores are better off as a result of the higher prices) but may decrease consumer surplus (i.e.,
consumers are worse off as a result of the higher prices). The higher prices also provide an incentive
for hardware stores to try to acquire more shovels to sell and to hold a large inventory of snow
shovels at the start of the winter; these decisions will increase social surplus.
5. The market for economics textbooks is in equilibrium. The government decides to relax export
restrictions on paper, leading to an increase in the demand for paper. How does social surplus in the
market for textbooks change? Why? Present a diagram as part of your explanation.
Answer: An increase in the demand for paper would also lead to an increase in the price of paper. As
the price of paper increases, the cost of producing a textbook will increase. This will shift the supply
curve for textbooks to the left. The equilibrium price of a textbook will increase while the equilibrium
quantity will fall. Consumer surplus and social surplus must fall; it is not clear if producer surplus
will rise or fall.

© 2015 Pearson Education, Inc.

71 Acemo
oglu, Laibson, and List | Micrroeconomics

The diagram ab
T bove shows demand
d and supply
s in the textbook
t markket. The increease in the price of
paaper shifts thee supply curvve for textbooks from S1 to S2. At the oldd price of papper consumer
suurplus was A + B + C + E,, producer surrplus was F + G + H, and social
s surpluss was A + B + C +
E + F + G + H. H At the new higher
h f paper conssumer surpluss is A, produccer surplus is B +
price for
F, and social su urplus is A + B + F. Thereefore consumeer surplus andd social surpluus both fell; the
t
im
mpact on prod ducer surplus is ambiguouss.
6. What could explain n why South Korea’s gross domestic prroduct (GDP) per capita inncreased so muuch
fasterr since the 197
70s than Nortth Korea’s GD
DP per capitaa?
Answeer: One of thee factors that could explainn the divergennce between SouthS Korea’s and North
Koreaa’s per capita GDP is the factfa that Southh Korea is a market
m econommy while Norrth Korea is a
comm mand economy y. The price mechanism
m alllocates resouurces in markeet economies to their mostt
efficieent use. It also aligns the inncentives of sellers
s and buuyers. Centrall planners in command
c
econoomies, howev ver, face coorddination and incentive
i probblems. The ceentral plannerr does not fullly
underrstand consum mer wants andd the productiion capabilitiees of every seector of the ecconomy, and it i is
difficuult to providee workers withh appropriatee incentives.
7. In a command econ nomy, a plannning agency sets
s prices forr various inpuuts and final goods.
g In a market
econoomy, supply and
a demand decide
d the pricces of variouss goods. In booth cases, therre is a set of prices
p
operaating in the economy. Thenn why are marrket economiees consideredd more efficient than plannned
econoomies?
Answeer: Although planning ageencies set pricces, they cannnot always acccurately alignn the interests of
buyerrs and sellers or solve the coordination
c p
problem of brringing agentss together to trade.
t Any
indiviidual can onlyy know a smaall fraction off all that is knoown collectivvely and so a planning
p agenncy
cannoot replicate the work of thee invisible hannd. In a markeet economy on o the other haand, the pricee
mechaanism ensures that econom mic agents maake trades thaat are in their best
b interest anda maximizee
sociall surplus.

© 2015 Peearson Education

n, Inc.
 Chapter 7 | Perfect Competition and the Invisible Hand 72

8. If your professor decided to give all of his students the highest grade in the class, would that affect
your classmates’ incentives to study?
Answer: If every student were given the same grade irrespective of how he or she did on an exam,
students’ incentive to study. Even without studying, a student would be ‘guaranteed’ a higher grade
than he would have received otherwise. Eventually, one can expect students in the class to stop
studying altogether.
9. Sofia, a political science student, thinks that the government should intervene to revive declining
industries like video rentals and print newspapers. The government, she reasons, can resolve the
coordination problem of getting the agents in these markets to trade. Do you agree with her? Explain
your answer.
Answer: Sofia’s reasoning is flawed because declining industries do not face a coordination problem.
A coordination problem results when economic agents with coinciding interests cannot be brought
together to trade. However, in this case, falling demand is responsible for the decline of industries like
video rentals and print newspapers. Even if the government attempted to bring together economic
agents in these industries, it is unlikely that demand for rented videos and newspapers will increase.
10. Are all efficient outcomes also equitable? Explain.
Answer: Equity is concerned with the distribution of resources across society. An efficient outcome is
one that maximizes social surplus. However, maximizing social surplus is not always consistent with
equity considerations. An economy can make the most efficient use of the resources that it has but at
the same time, these resources may not be equally distributed in society.
11. Are there real-world markets that resemble double oral auctions? Suppose you had to organize a
double oral auction for a good that has perfectly elastic demand. Do you expect prices to approach the
competitive equilibrium?
Answer: Double oral auctions are similar to how trading actually works on stock exchanges—traders
announce bids and asks and if they match, a trade is executed.
Double oral auction experiments with many different market variants - including varying the
elasticity of supply and demand and the numbers of buyers and sellers - have shown that the
equilibrium price in the market will be very close to where the supply and demand curves intersect.
So, the price in a double oral auction for a good with perfectly elastic demand is also expected to
approach the equilibrium price.
12. Imagine you are a buyer in a double oral auction with a reservation value of $10 and there is a seller
asking $8.
a. How much will you gain from accepting this offer?
b. If you are the only buyer, and you know that the lowest ask price is $2, should you accept this
offer?
Answer:
a. By accepting this offer, you will gain $2 ($10 – $8).
b. Yes. By accepting this offer, you will gain $8 ($10 – $2). If you choose to accept an offer
from a different seller, your surplus will be lower. By accepting the lowest ask price of $2,
you will maximize your surplus from this trade.

© 2015 Pearson Education, Inc.

73 Acemo
oglu, Laibson, and List | Micrroeconomics

Problem
ms
1. The following
fo diaggram shows thhe market dem mand and maarket supply for fo sweaters. Calculate
C
consuumer surplus, producer surpplus, and sociial surplus in this market.

Answeer: Producer surplus is thee area of trianggle I and is eqqual to ½ x 1000 x (60 – 20) = 2000.
Consuumer surplus is the area off triangle II annd is equal to ½ x 100 x (90 - 60) = 15000. Social surpplus
is the sum of consu
umer surplus and producerr surplus and is equal to 15500 + 2000 = 3500.

© 2015 Peearson Education

n, Inc.
 Chapter 7 | Perfect Competition and the Invisible Hand 74

2. Look at Exhibit 7.1 in the chapter that shows the reservation values of the buyers and sellers in the
iPod market. Suppose trades are arranged in this market such that everyone can make a trade without
losing money. So, Madeline buys from Fiona at a price of $70, Katie buys from Matt at a price of
$60, Sean buys from Adam at a price of $50 and so on.
Reservation Values of Buyers and Sellers in the iPod Market
Buyers Value($) Sellers Cost ($)
Madeline 70 Tom 10
Katie 60 Mary 20
Sean 50 Jeff 30
Dave 40 Phil 40
Ian 30 Adam 50
Kim 20 Matt 60
Ty 10 Fiona 70
Since everyone who wants an iPod obtains one, and everyone who wants to get rid of their iPod sells
it at the price they wanted, is social surplus maximized in the market?
Answer: When trades are arranged in the market such that the buyer’s reservation values are matched
with the minimum price that the sellers are willing to accept, the social surplus in the market is equal
to zero. For example, Madeline buys an iPod from Fiona for $70. Since this is the maximum that
Madeline was willing to pay and the minimum that Fiona was willing to accept, there is no producer
surplus or consumer surplus from this trade. This will hold for all the trades between the other
participants and the social surplus will be zero.
Buyers Value($) Sellers Cost ($)
Madeline 70 Fiona 70
Katie 60 Matt 60
Sean 50 Adam 50
Dave 40 Phil 40
Ian 30 Jeff 30
Kim 20 Mary 20
Ty 10 Tom 10
3. There are four consumers willing to pay the following amounts for an electric car:
Consumer 1: $70,000 Consumer 2: $20,000 Consumer 3: $80,000 Consumer 4: $40,000
There are four firms that can produce electric cars. Each can produce one car at the following costs:
Firm A: $30,000 Firm B: $60,000 Firm C: $40,000 Firm D: $20,000
Each firm can produce at most one car.
Suppose we wanted to maximize the difference between consumers’ willingness to pay for electric
cars and the cost of producing those cars, i.e., we wanted to maximize social surplus.
a. How many electric cars should we produce?
b. Which firms should produce those cars?

© 2015 Pearson Education, Inc.

75 Acemoglu, Laibson, and List | Microeconomics

c. Which consumers should purchase those cars?

d. Find the maximum social surplus in the electric car market.
Answer:
a. We should produce three cars. The value of the fourth car would be just $20,000 and would
cost $60,000 to produce.
Consumers Firms
(I) (II)
$80,000 3 $20,000 D
$70,000 1 $30,000 A
$40,000 4 $40,000 C
$20,000 2 $60,000 B
b. The three lowest cost firms should produce: Firms A, C, and D
c. The three consumers who value electric cars the highest should own electric cars: Consumers
1, 3, and 4.
d. Willingness to pay of the consumers = $80,000 + $70,000 + $40,000 = $190,000
Total Cost = $20,000 + $30,000 + $40,000 = $90,000
Social surplus = $190,000 – $90,000 = $100,000
4. Let us continue with the electric car example from problem 3. Suppose the market for electric cars is
competitive.
a. Show that the equilibrium price in this market is $40,000.
b. Which firms will produce an electric car if the price is $40,000?
c. Which consumers will buy an electric car when the price is $40,000?
d. Calculate consumer, producer surplus, and social surplus when the price is $40,000.
e. Compare your answers to those for problem 3.
Answer:
a. When the price is $40,000, three consumers (all except 2) are willing to buy an electric car
because their willingness to pay is greater than or equal to price. Three firms (all except B)
are willing to sell an electric car since their cost is less than or equal to the price. Therefore
supply equals demand when the price is $40,000.
b. Firms A,C, and D
c. Consumers 1,3 and 4
d. Consumers 1, 3, and 4 are willing to pay a total of $80,000 + $70,000 + $40,000 = $190,000
for three cars. At a price of $40,000 they will pay 3 x $40,000 = $120,000 for those cars.
Therefore consumer surplus equals $190,000 - $120,000 = $70,000. It will cost Firms D, A,
and C a total of $20,000 + $30,000 + $40,000 = $90,000 to produce those cars. At a price of
$40,000 their revenues equal 3 x $40,000 = $120,000 Therefore producer surplus equals
$120,000 - $90,000 = $30,000. Social surplus is the sum of consumer and producer surplus.
Therefore social surplus equals $70,000 + $30,000 = $100,000.

© 2015 Pearson Education, Inc.

 Chapter 7 | Perfect Comp
petition and thee Invisible Han
nd 76

e.. The point here

h is that coompetitive maarkets lead too efficiency. The
T market ouutcome here leads
to the max
ximum social surplus we foound in probleem 3.
5. The following
fo figu
ure shows the demand and supply of teleevision sets inn a city. Sincee TVs are
considdered normal goods, demaand increases from D1 to D2 in response to an increasse in the incom
me
level.

a. Use
U the figure to complete the
t table beloow:
Befo
ore Income Ro
ose After Income
I Rose Chaange

Co
onsumer Surp
plus

Prroducer Surplus

So
ocial Surplus

b. Use
U your answ
wers to part (a) of this problem to answeer the followinng questions:
i. Did coonsumer surpllus definitely rise, definitely remain connstant, definittely fall, or is the
directiion of the chaange in consum
mer surplus unclear?
u
ii. Did prroducer surpluus definitely rise,
r definitelyy remain constant, definiteely fall, or is the
t
directiion of the chaange in produccer surplus unnclear?
iii. Did so
ocial surplus definitely
d risee, definitely reemain constannt, definitely fall, or is the
directiion of the chaange in social surplus uncleear?

© 2015 Peearson Education

n, Inc.
77 Acemoglu, Laibson, and List | Microeconomics

Answer:
a. The completed table is as follows:
Before Income Rose After Income Rose Change

Consumer Surplus A+C A+B B–C

Producer Surplus F F+C+D C+D

Social Surplus A+C+F A+B+F+C+D B+D

b. As shown in the table:

i. The change in consumer surplus is B – C. We do not know if B is greater than or less
than C and so we do not know if consumer surplus rose or fell.
ii. Producer surplus rises by C + D.
iii. Social surplus rises by B + D.
6. The market for electric drills in a certain country is characterized by a large number of buyers and
sellers and every buyer who wants a drill and can afford one has bought one. In other words, the
market for drills is in equilibrium.
a. Does this also mean that it is Pareto efficient? Explain your answer.
b. If some of the buyers in this market are now willing to pay more than they did earlier, would your
answer change?
c. Compared to the market for cars, the market for vintage buttons has fewer buyers and sellers.
Social surplus is likely to be higher in the market for cars than in the vintage button market. Is it
then correct to assume that the outcome in the car market is Pareto efficient while in the vintage
button market it is not? Explain.
Answer:
a. An outcome is Pareto efficient if no individual can be made better off without making
someone else worse off. A competitive market maximizes social surplus and so the market
outcome is Pareto efficient. Assuming that none of the large number of sellers has enough
market share to influence price, the market for electric drills is competitive, social surplus is
at its maximum and so, the market outcome is Pareto efficient.
b. The level of social surplus might increase if buyers are now willing to pay more than they did
earlier but as long as the competitive market equilibrium holds, the market outcome is still
Pareto efficient.
c. While social surplus in the market for vintage buttons is lower than in the market for cars, it
is incorrect to assume that the equilibrium in the car market is Pareto efficient while the
equilibrium in the vintage button market is not. The size of the social surplus in the market
does not determine whether the market is Pareto efficient or not. Pareto efficiency would only
depend on whether an individual can be made better off without making someone else worse
off.

© 2015 Pearson Education, Inc.

 Chapter 7 | Perfect Competition and the Invisible Hand 78

7. The following tables show a small firm’s long-run average cost of manufacturing a good at two
different plants:
Plant 1
Quantity Total Cost Average Cost Marginal Cost
1 50
2 106
3 164
4 224
5 287
6 355
7 430
8 520
9 618

Plant 2
Quantity Total Cost Average Cost Marginal Cost
1 20
2 52
3 90
4 130
5 175
6 227
7 285
8 345
9 407

a. Complete the third and fourth columns of each table.

b. Suppose the price of the good is $60. How much should the firm produce in each plant in order to
maximize the firm’s profit? Find the firm’s profit.
c. A new manager is assigned to the production department. He thinks that the firm can profitably
move all production to Plant 2 since the average cost of production is lower in Plant 2 than in
Plant 1. If the firm only uses Plant 2, how much should it produce in order to maximize profits?
Find the firm’s profit. Assume zero fixed cost.

© 2015 Pearson Education, Inc.

79 Acemoglu, Laibson, and List | Microeconomics

Answer:
a.
Plant 1
Quantity Total Cost Average Cost Marginal Cost
1 50 50.00 50
2 106 53.00 56
3 164 54.67 58
4 224 56.00 60
5 287 57.40 63
6 355 59.17 68
7 430 61.43 75
8 520 65.00 90
9 618 68.67 98

Plant 2
Quantity Total Cost Average Cost Marginal Cost
1 20 20.00 20
2 52 26.00 32
3 90 30.00 38
4 130 32.50 40
5 175 35.00 45
6 227 37.83 52
7 285 40.71 58
8 345 43.13 60
9 407 45.22 62
b. Since the price of the good is $60, profits are maximized when marginal cost of production is
equal to $60 at both plants. This occurs when 4 units are produced at Plant 1 and 8 units are
produced at Plant 2. The firm’s revenue will be 12 x $60 = $720, its total costs will be $224 +
$345 = $569, and it will earn a profit of $720 - $569 = $151.
c. If the firm uses just Plant 2 it would maximize profits by producing just 8 units (since price
equals marginal cost in Plant 2 at 8 units). Its revenue will be 8 x $60 = $480, its cost will be
$345, and its profit will be $480 - $345 = $135.

© 2015 Pearson Education, Inc.

 Chapter 7 | Perfect Comp
petition and thee Invisible Han
nd 80

8. The following
fo figu
ure shows a firm’s marginaal and averagee costs of production.

a. T
The equilibrium
m price in thiis market is $5. At this pricce, does the fiirm earn proffits or is it makking
loosses?
b. Frrom the givenn informationn, can you connclude whetheer the firm is operating in a competitivee
m
market? Explaain your answer.
c. The
T price of th
he good increaases to $8. Hoow does this change
c your answer
a to parrts a and b?
Answeer:
a.. At a price of $5, the firm
m produces 60,000
6 units of
o the good. Itt does not earnn profits or loosses.
nue from 60,0000 units = $3300,000
Total reven
Total costss of producingg 60,000 unitts = $300,000
Since totall costs = total revenues, proofits are equaal to zero.
b.. Firms in co
ompetitive markets
m earn zeero economicc profits in thee long run. Att a price of $55, this
firm earns zero econom
mic profits. Soo from the givven informatioon, we can coonclude that thhe
firm may be
b operating in
i a competitiive market.
c.. If the mark
ket price increeases to $8, thhe firm will produce
p 80,0000 units of thee good.
Total reven
nue from 80,0000 units = $6640,000
Total costss of producingg 80,000 unitts = $440,000
Since total revenuee exceeds totaal costs by $2200,000, the firm
fi earns ecoonomic profitss. In the long run,
competitive firms earn
e zero ecoonomic profitss. This firm makes
m positivee economic prrofits when thhe
price is $8. This is however, nott sufficient too conclude thaat the firm is not
n operating in a competitive
markeet. This firm might
m be operrating in the short
s run wheere new firms have not enteered the markket
and coompeted awaay its profits.

© 2015 Peearson Education

n, Inc.
81 Acemo
oglu, Laibson, and List | Micrroeconomics

9. Hospiitals in City A are profit maximizing

m peerfectly competitive firms. Hospitals in City B, on the
other hand, are run n by non-profifit charities that try to minim
mize the longg-run average cost of treatiing
patiennts. Hospitals in both citiess have the sam me average annd marginal cost.
c Show thaat hospitals inn both
cities will be the saame size.
Answeer: Hospitals in City B treaat the numberr of patients thhat minimizees long run avverage cost
(LRAAC). Hospitalss in City A wiill equate pricce and marginnal cost in ordder to maximiize profits andd
thereffore, the equillibrium price must equal loong run marginal cost (LRRMC). Entry will
w eliminate
(econnomic) profits and so in equuilibrium, price must also equal LRAC.. When LRAC C equals LRMMC,
LRAC C is minimizeed. So, for hospitals in Cityy A, price is equal
e to LRM
MC which is eqqual to the
minimmum point of LRAC. Therefore, hospitaals in both cities will buildd hospitals thaat treat the samme
numbber of patientss.

In thee diagram abo

ove, hospitals in both citiess will serve Q1 patients.

© 2015 Peearson Education

n, Inc.
 Chapter 7 | Perfect Comp
petition and thee Invisible Han
nd 82

10. The equilibrium

e reent in a town is
i $500 per month
m and the equilibrium number
n of apartments is 1000.
The city
c now passees a rent contrrol law that seets the maximmum rent at $4400. The diaggram below
summ
marizes the sup pply and demmand for aparttments in thiss city.

a. Use
U the figure to complete the
t table beloow

Befo
ore Rent Conttrol After Rent
R Control Chaange
Co
onsumer Surp
plus

Prroducer Surpllus

So
ocial Surplus

b. Use
U your answ
wers to part (a) of this problem to answeer the followinng questions:
i. Did coonsumer surpllus definitely rise, definitely remain connstant, definittely fall, or is the
directiion of the chaange in consum
mer surplus unclear?
u
ii. Did prroducer surpluus definitely rise,
r definitelyy remain constant, definiteely fall, or is the
t
directiion of the chaange in produccer surplus unnclear?
iii. Did so
ocial surplus definitely
d risee, definitely reemain constannt, definitely fall, or is the
directiion of the chaange in social surplus uncleear?

© 2015 Peearson Education

n, Inc.
83 Acemoglu, Laibson, and List | Microeconomics

Answer:
a. The completed table is as follows:

Before Rent Control After Rent Control Change

Consumer Surplus I + II I + III III – II

Producer Surplus III + IV + V V – III – IV

Social Surplus I + II + III + IV + V I + III + V – II – IV

b. As shown in the table:

i. The change in consumer surplus is III – II and so it is not clear if consumer surplus rose
or fell. The consumers who rent those 60 apartments that are available under rent control
are better off because they now pay $400 per month instead of $500; this benefit is area
III. But the people who cannot find an apartment under rent control are worse off. They
lose the consumer surplus they realized from the 40 apartments that are no longer
available as a result of rent control; this loss is area II.
ii. Suppliers are unambiguously worse off as a result of price controls. They receive $400
per month instead of $500 per month for each of the 60 apartments they continue to offer
under rent control (area III) and they lose the producer surplus they realized from the 40
apartments they no longer offer (area IV).
iii. Total surplus falls by the sum of II (lost consumer surplus from the 40 apartments that are
no longer offered) and IV (lost producer surplus from those 40 apartments).
11. According to reports in the Chinese media, commuters in Beijing are facing a somewhat paradoxical
situation: they find it difficult to get a cab while hundreds of cabs lie idle during rush hour. The
demand for taxis in Beijing has increased as average incomes have risen. Government-determined
gasoline prices have also increased. But the government, worried about rising prices, has left the fares
cabs can charge their customers unchanged.
a. Use supply and demand curves to explain what has happened in the market for cabs in Beijing.
b. Based on your understanding of how the invisible hand works, what do you think should be done
to correct this problem?
Answer:
a. The following diagram shows the demand and supply curves for cabs in Beijing. The increase
in demand causes the demand curve to shift to the right. Since gasoline prices have increased,
the cost of running a cab in Beijing has also increased. This will shift the supply curve to the
left. The equilibrium quantity may or may not change depending on the degree to which both
curves shift but the equilibrium price in the market will increase. However, since the
government does not allow cab fares to increase, the number of cabs demanded exceeds the
supply. This explains why commuters are unable to find a cab when they need one.

© 2015 Pearson Education, Inc.

 Chapter 7 | Perfect Comp
petition and thee Invisible Han
nd 84

As can be seen in the figure, the incrrease in demaand and decrease in supply have actuallyy
increased the
t equilibriuum price from m P to P’. The equilibrium quantity
q shouuld also have
increased from
f Q to Q’. The distancee between Q0 and Q1 show ws the extent by
b which dem mand
exceeds su
upply as a resuult of the pricce control.

Market for Cab Rides

R

b.. An increasse in demand combined wiith a decreasee in supply im mplies an increease in price.
Therefore, to fix this prroblem, the caab fare must be
b allowed to increase. Forr the market too be
in equilibrrium, fares muust be allowedd to increase to P’. At this price, quantitty supplied will
w
equal demand at the quaantity demandded.
See htttp://www.economist.com//node/215515537 and
http:///www.theatlaantic.com/inteernational/archhive/2013/01/its-harder-thhan-ever-to-caatch-a-cab-in--
beijinng/267239/
12. The following
fo quote is from a section on foood shortages inn a book on thhe Soviet ecoonomy:
"Why there is no fiish ... I can't imagine,"
i wroote one indignnant citizen too Anastas Mikkoyan, head of
o the
Food Ministry, in 1940.
1 "We haave seas, and they are still the same as before,
b but theen you could have
y wanted off whatever kinnd, and now I have even foorgotten whatt it looks like."
as muuch [fish] as you
Industries and agriiculture in thee former Soviet Union were state-controolled and the economy’s
e
resourrces were allo
ocated by a ceentral agencyy, Gosplan. Inn the above paassage, the citizen cannot
underrstand why there is a shortaage of fish altthough the coountry possessses the same resources
r thatt it
did beefore the econ
nomy transitiooned to centraal planning. What
W could exxplain this ouutcome?
Answeer: The shortaage of fish coould be explaiined by the faact that the economy was centrally
c plannned.
A cenntral planningg agency is unnlikely to corrrectly estimatee the demandd for various goods,
g in this case,
fish. It
I is also not likely
l to be abble to match production
p caapabilities witth the econom
my’s resourcess. In
other words, since central plannning agencies cannot repliccate the work of the invisibble hand,
mismmatches betweeen demand annd supply are likely to exisst in the econoomy.
From: Everyday Sttalinism: Orddinary Life in Extraordinar
E ry Times: Sovviet Russia in the 1930s (Shheila
Fitzpaatrick)

© 2015 Peearson Education

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Title: The basic facts of economics

A common-sense primer for advanced students

Author: Louis F. Post

Release date: April 27, 2024 [eBook #73475]

Language: English

Original publication: United States: Columbian Printing Co., Inc,

1927

Credits: Aaron Adrignola and the Online Distributed Proofreading

Team at https://www.pgdp.net (This book was produced
from images made available by the HathiTrust Digital
Library.)

*** START OF THE PROJECT GUTENBERG EBOOK THE BASIC

FACTS OF ECONOMICS ***
The Basic Facts
of Economics
A COMMON-SENSE PRIMER
FOR ADVANCED STUDENTS

By Louis F. Post

Author’s Edition

WASHINGTON, D. C.
2513 TWELFTH STREET, N. W.
1927

Price Fifty Cents

 Copyright, 1927, by
Louis F. Post
PRESS OF
COLUMBIAN PRINTING CO., INC.
BINDING BY
GEO. A. SIMONDS & CO.
WASHINGTON, D. C.
Accurate Observation and Clarity of Thought
are the Prime Requisites of Economic Study
 Publication Committee
Andrew P. Canning, Chairman, Chicago, Ill.

James H. Barry,
San Francisco, Calif.
George A. Briggs,
Los Angeles, Calif.
Mrs. Edward O. Brown,
Chicago, Ill.
Edmund Vance Cooke,
Cleveland, Ohio.
Stoughton Cooley,
Los Angeles, Calif.
Otto Cullman,
Chicago, Ill.
Mrs. Anna George de Mille,
New York City.
James H. Dillard,
Charlottesville, Va.
Robert E. Graves,
Chicago, Ill.
Angeline Loesch Graves,
Chicago, Ill.
William C. Harllee,
Washington, D. C.
Lewis J. Johnson,
Cambridge, Mass.
Fenton Lawson,
Cincinnati, Ohio.
Wiley Wright Mills,
Chicago, Ill.
C. L. Moulton,
Glen Ellyn, Ill.
Jackson H. Ralston,
Palo Alto, Calif.
Walter I. Swanton,
Washington, D. C.
Edward N. Vallandigham,
Chestnut Hill, Mass.
John Z. White,
Chicago, Ill.
 Table of Contents
PAGE
Preface vii
First Lesson—Economics 1
Second Lesson—Money 9
Third Lesson—Trade 17
Fourth Lesson—The Basic Facts 27
Fifth Lesson—The Productive Process 40
I. Human Factors 42
II. Natural Resource Factors 50
III. Artificial Objects 52
IV. Secondary Categories 56
1—Capital 56
2—Trade 60
3—Utility, Value, Money, Price, Banks 63
4—Balances of Trade 67
V. An Illustration of the Productive
Process 70
Sixth Lesson—Distribution 74
I. Wages for Labor 75
II. Rent for Landownership 83
III. Trade 91
IV. Money 94
Seventh Lesson—Review 97
Questions for Self-Examination 101
Personal Acknowledgments 103
 PREFACE
The purpose of this common-sense explanation of Economic
phenomena is to disclose and emphasize those comprehensive and
familiar primary facts which embody the myriads of secondary facts
that are involved in Economic science. To avoid confusing those
complicated details is to promote the clear thinking which every
Economic problem demands, be the problem one of collegiate study,
of political policy, or of business importance.
The following pages aim, therefore, at encouraging all thoughtful
citizens so to classify the details of the general subject in their own
minds as to enable them to avoid centering their mental vision upon
Economic trees so intently that they cannot see the Economic forest
as a whole. It aims also at discouraging the opposite inclination to
view the Economic forest so exclusively as a whole that the
Economic trees of which it is composed cannot be distinguished.
L. F. P.
 The Basic Facts of Economics
A COMMON-SENSE PRIMER
FOR ADVANCED STUDENTS

FIRST LESSON
ECONOMICS
ON the surface, Economics appears to be the science of making
money.
This appearance is due, however, to a careless recognition and
erroneous application of the fact that Economic accomplishments
are measured by money standards and expressed in money terms.
When, for example, a builder builds, he builds to make money.
Money measures the Economic extent of what he is doing, and
money terms express its Economic desirability. They also express
and measure his motive, which is the compensation he can
command in the currents of trade.
A merchant makes money when he manages a profitable
business.
So does a manufacturer.
Farmers make money when they sell their produce profitably.
Nor only when they sell it, but also while they cultivate it; for every
day’s growth adds to the money measurement of a crop.
Wage-workers by the day, the week or month, and salary-
workers by the year, also workers on commission or for percentages
or for profits, make more or less money as working opportunities are
more or less plentiful, and wages or salaries or percentage totals
and profit totals are consequently higher or lower.
Engineers, lawyers, physicians, architects, dentists, clergymen,
teachers—all professional workers,—make money to the extent of
the marketability of the services they offer.
And investors, do they not invest by money measurements and
in money terms for the purpose of obtaining Economic incomes
measured by money and expressed in terms of money?
Manifestly, the immediate object of everybody’s activity in the
field of Economics is to make money.
Does one desire food? By making money he gets food. Does
one desire clothing? He gets it by making money. Does he wish for
housing, furnishings, automobiles, railway or steamboat
transportation, necessaries of any kind, luxuries of whatever variety,
household service, professional service, legislative or judicial
service, mechanical service, mercantile service, clerical service? By
making money he gets them. Does one wish for slaves? If slavery be
an institution of his time and place, he may have slaves by
purchases with the money he makes. Should he be a slave himself,
he may purchase his freedom with money if he can get it. Does land-
ownership appeal to one? Let him make money and he can buy
land. Whatever object the Economic field may offer for the
satisfaction of human desires, that object is attainable by making
money. In no other way can it be attained through Economic
processes.
If gifts be cited as exceptions let the fact be noted that giving is
not an Economic process. It lacks the element of exchange or trade.
So, too, of theft in any of its forms. In genuine Economics there must
be two gainers in every trade. There is no such science as
Economics of the Forty Thieves variety.
Even in such seeming exceptions to the Economic importance of
money as are offered by barter, in which no money passes and no
money accounting is made, comparisons of the objects thus directly
exchanged are nevertheless contemplated by the exchangers in
terms of money. The owner of a horse that might sell for two hundred
dollars, would not barter it for a horse that could sell for only one
hundred—not unless he got “boot” enough to even up the money
difference to his satisfaction. Nor would the boy with a two-dollar
penknife “swap even” for a one-dollar jackknife. It is only when the
two horses or the two knives seem to their respective owners to be
approximately equal by money measurement that an “even swap” is
conceivable.
Another seeming exception to the money-making characteristic
of Economics depends upon individual isolation. That isolated
individuals may gather food and improvise shelter and clothing
without thinking of them in terms of money, is true enough; but the
activities of persons thus isolated are not Economic exceptions, for
the science of Economics is a social science. Although some
Economic phases or phenomena may be picturesquely and aptly
illustrated by reference to the experience, actual or imaginary, of
isolated individuals like Robinson Crusoe on his island, states of
human isolation are outside the limits of Economics.
Inasmuch, then, as the object of the human factor in the science
of Economics is to make money, and as there can be no science of
Economics without the human factor, Economics is comprehensively
and accurately definable, on the surface, as the science of making
money.
But making money in the Economic sense must be distinguished
from narrower uses of the phrase. To manufacture coins legitimately,
as at a mint, is to “make money,” but only in one Economic particular
—only in the narrow mechanical sense in which weaving cloth is
“making cloth.” Like weaving cloth, it is but an item in the
multitudinous phenomena of that money-making which superficially
defines the science of Economics. The same observation is
applicable to the occupations of engraving and of printing paper
currency legitimately.
Illegitimate makings of either paper currency or coin, like all
other forms of forgery, are not in any sense making money within the
purview of Economic science. They are varieties of theft, and
Economic science excludes theft of every kind, even legal kinds,
such as slavery. This exclusion is not for moral reasons, it may be
well to interject for the benefit of such advanced students of
Economics as recoil from mixing moral principles with Economic
science. It is due to the fact that exchange, or trade—an essential
element in Economics,—is in theft utterly lacking.
In the Economic sense, making money is making it for all
concerned in any particular process, and not for one or more of the
parties at the expense of the others. No art of getting something for
nothing can be within the scope of Economic science. One-sided
methods of making money, whether frankly labeled “theft” or
“gambling,” or shrewdly disguised in spurious business ethics, are
alien to Economic money-making. Within the domain of Economics
no money-making transaction belongs unless it involves the making
of money by all parties to the transaction.
To make money in that mutual sense is to augment the supply or
the serviceableness of whatever commodities money terms may
measure and express, and of the portions or shares of all who
contribute to the augmentation.
In phrasing more complete than that of “making money,”
Economics is the science of making money by earning it. Getting
money without earning it is related to Economics only in a science-
disturbing sense. It disturbs the normal Economic relations of effect
to cause in the production and dissemination of humanly desirable
objects. To realize the truth of that statement, the student need only
momentarily conceive of theft as universal. Since universal theft as
an Economic phenomenon would be utterly destructive of normal
Economic relationships, of beneficial effects from normal causes, so
must theft to any extent operate destructively to that extent. The only
thinkable relation of theft to Economics is analogous to the relation of
murder to the human race. That Economic study may comprise
considerations of how to exclude stealing from Economic customs,
does not go to prove that stealing is a factor in Economic science. It
goes no farther than to prove that stealing may become an
Economic parasite.
 Even as a parasite, stealing could hardly have wormed its way to
the Economic border line, much less across it, but for a disposition
among advanced students to confuse normal Economic phenomena
with arbitrary business customs.
“Business” might indeed be the nearest approach to a synonym
for “Economics.” It would be an exact synonym but for one variation.
Whereas Economics relates to a comprehensive social organism
which (notwithstanding “scientific” contentions to the contrary) is
subject to natural laws of human association (sequences of cause
and effect), Business is but a limited collection of individual interests
or private organizations that are influenced and largely governed by
arbitrary customs. These customs may or may not be in harmony
with the normal relations of cause and effect in Economics. And as
to each particular business, it is operated, as accountants frankly
1
admit, only “for the benefit of its proprietor.”

1
The quotation is from “Modern Business”, by Thomas
W. Mitchell, Ph. D. New York: Alexander Hamilton Institute.
1918–1919.

In some of its vulgar connotations Business might very well

answer to the insolent definition that it consists in the adventures of
sprightly gentlemen trying to sell nothing for something to other
sprightly gentlemen who are trying to buy something for nothing. In
so far, however, as that definition may be appropriate, it applies only
to business abuses, not to Business as a possible synonym for
Economics. It defines Business only as theft might define morality.
To be a closer synonym for Economics, Business must deserve
a definition relating its customs to natural Economic law (a subject to
be considered in a later Lesson) and extending its functions more
completely to universal mutual service. Moreover, its definition must
widen the Business concept so as to include all kinds of such
service. Business can no more exclude from its realm particular
Business specialties, though that be customary, than it can include
the operations of “confidence men,” as it is sometimes supposed to
do. Its functions are not limited to commerce, nor to banking, nor to
any other of those Business specialties to which careless speech,
and sometimes snobbish thought, tend to narrow the meaning of the
word.
Business is that function of social life which includes all
serviceable specialties. Such terms as “commercial,” “mercantile,”
“industrial,” “agriculture,” “labor,” “the professions,” and so on,
denominate specializations or sections or subsidiary departments of
Business, not Business as a whole. They are useful for
subclassification; but, like all subclassifications, whether in
Economics or in any other science, they are misleading when
perverted into general terms for primary or fundamental or
comprehensive categories. The term Business, like the term
Economics, should include them all. Every kind of service
necessitates busy-ness; and serviceable busy-ness, what is that but
Business?
Considered comprehensively, then, and excluding parasitical
adhesions, Business might be, as some advanced students of
Economic phenomena suppose it to be, another name for
Economics. In the scholastic sense, Economics is the more orthodox
term; in the practical sense Business could better express the idea.
Both terms might have practically the same meaning if considerately
used. Honest Business, inclusive of all serviceable activities—
service for service, to adopt a phrase in definition of Business—
would be identical with Economics. Either, like the other, may be
described superficially as the process of the science of making
money.
Quite consistently with the foregoing survey, Economics has
been described as the science of “mankind making a living.” This
definition, too, excludes the solitary life by limiting Economic science
to cooperative mankind—in other words, to Economic association. It,
too, identifies Economics and legitimate Business; for only through
legitimate Business activities can cooperative mankind make a living.
It, too, excludes theft in all its forms and guises; for so much of a
living as some may make by any kind of theft, others must lose as
victims of theft. It, too, brings Economics on the surface and
Business on the surface within the definition of “the science of
making money;” for only by means of money measurements in
money terms does or can mankind in the mass make its living.
But making money is only a surface fact in Economics. It is but a
means to the end. By no possibility can it be rationally regarded as
the ultimate object. The ultimate object of Economics is earning the
living that money will buy. Both the object and the method lie below
the surface of money-making. To Economics, making money is
somewhat as book-keeping is to a commercial business. It is the
surface expression of all underlying Economic phenomena.
Before those phenomena can be thoughtfully observed and
studied, the relation to them of money-making must be keenly
scrutinized and intelligently considered.
 SECOND LESSON
MONEY
WHAT is Money? and what are its functions? Money is the medium
of trade, its denominations the language.
Resting on the surface of Economic phenomena, Money and
Money terms spread over the whole of the Economic area. All
subsurface phenomena in Economics are measured in trade by
Money units; the details of trading transactions are discussed and
recorded in Money terms.
Money terms vary with localities. In the United States, Money
talks in terms of “dollars;” in Great Britain in terms of “pounds
sterling;” in France in terms of “francs;” in Germany of “marks;”
elsewhere in local terms too numerous for other than encyclopedic
description. But the value measurements that Money makes of
commodities in the processes of trade are everywhere, at any given
time, practically the same.
For lack of stability those measurements do vary from time to
time with confusing effect. To compare them with measuring rods for
length, breadth and thickness, it is as if yards, feet and inches were
constantly contracting and expanding with reference not only to the
magnitude of measurable objects but also to one another. Precisely
in that way does Money in fact fluctuate. It always has, and unless
scientifically standardized, it always will.
Nevertheless, whatever the fluctuations and local discrepancies
of Money may be, it everywhere talks, when its language is
translated, to the same general Economic effect at any given time.
Stabilized, as it might be, it would talk to the same general Economic
effect everywhere and all the time.
 What language is to thought, Money terms are to trade. The
trading transactions of the whole world are effected by means of
Money standards and in the language of universally interpretable
Money terms.
Conventionally defined, Money consists of coins minted by
governments from precious metals more or less alloyed. Those
forms are supplemented, however, with subsidiary forms commonly
known as “currency.”
There is an Economic theory that metal coins alone are Money,
paper currency being but promissory notes redeemable in coin. This
theory is useful for testing Money media by coinage standards. But
with reference to nearly if not all purposes of current trade, the
intrinsic value of the Money piece is of slight Economic importance,
or would be if Money were stabilized.
What counts in Economic measurements is Money
denominations—Money language rather than Money pieces. For in
the world-wide processes of trade, only a slight proportion of either
metal coin or paper currency passes from hand to hand. Nearly all
Money measurements are entered in books of account; and in these
the debits and the credits so nearly offset one another, by and large,
that the difference as a whole is too slight for consideration in
passing down from the Money surface of Economics to the basic
facts. A common and impressive exemplification is afforded by
clearinghouse statistics. These show that the enormous banking
transactions in Money terms which merge at the clearings daily, are
balanced off with a trifling percentage of tangible Money.
Let the fact be emphasized then, that in defining Money as the
medium of trade, Money terms rather than Money forms are to be
understood as the trading medium.
When a customer at a retail store buys a supply of groceries, his
payment may be made in Money pieces, either metal or paper. Yet it
may be made instead with a check drawn against his bank balance,
or through a charge to his account in the retailer’s books. If paid in
Money pieces, either at the time of purchase or later, some if not all
of those pieces will go to the storekeeper’s bank and be credited to