Questions for Review with Answers
Chapter 21. Price Theory. Functions and Behaviour of Prices. Value Theories
I. Basics
Chapter 21 – Question 1
Distinguish absolute and relative prices.
* Absolute prices are monetary prices. Relative prices are barter prices.
II. Functions of Prices
Chapter 21 – Question 2
Explain why prices are the free-market counterpart of central planning.
* Prices ration scarce goods by making them expensive. They allocate resources to the most profitable uses, i.e. to the production of the most profitable goods. They co-ordinate individual decisions. They answer the three basic economic questions.
III. The Behaviour and Formation of Prices in Economic Theory
Chapter 21 – Question 3
Please explain the major reasons for the perishability of goods in capitalist countries.
* Goods are perishable because they are very soon outmoded by innovation and because anything you have not sold costs storage costs and interest foregone or to be paid.
Chapter 21 – Question 4
What is the air example?
* The air example serves the purpose of demonstrating that prices are the result of relative scarcity. This is dubious. Air is free because it cannot be parcelled out or wrapped.
Chapter 21 – Question 5
List four reasons for sticky prices.
* (1) Co-ordination failure, firms wait until other firms have changed prices. (2) There is no change in costs or mark-ups. (3) Firms prefer to lower quality rather than raise prices. (4) Firms avoid menu costs.
IV. Price Formation in Economic Reality
Chapter 21 – Question 6
What tells consumers that price formation is not controlled?
* Identical or very similar goods are sold at different prices.
Chapter 21 – Question 7
What precisely is the trial-and-error process that is prevalent when prices are uncontrolled?
* Suppliers usually set a price without knowing exactly what competitors charge or what consumers are really able and willing to pay. Thereafter, they often revise their initial decision. They raise prices when their goods sell easily and lower them when they cannot get rid of their goods.
Chapter 21 – Question 8
Make a list of the goods and services you buy regularly and decide how their prices are formed.
* Price formation for goods that almost all households buy:
Housing - unless subject to rent control, rent is formed by a trial-and-error process on a relatively transparent market.
Electricity, gas, water - set by public monopolies, some of which are faced with competition from private suppliers, which tends to make the market confusing rather than transparent.
Telephone charges - since monopolies were busted, there has been fierce competition between a large number of suppliers with a bewildering variety of rates and offers.
Food and beverages - trial and error, subject to fierce price competition between large firms.
Clothing - trial and error including arbitrariness, fierce competition.
Household appliances and consumer electronics - trial and error, fierce competition between large companies.
Computer software - trial and error, fierce competition between large companies, untransparent market. Part of the market is more or less controlled by Microsoft.
Petrol -set by OPEC and oil companies.
Theatre and cinema tickets - local trial-and-error process.
Cigarettes, newspapers and (in some countries) books - prices are fixed by producers.
Cosmetics - prices are extraordinarily high and seem to be set by collusive agreements among large corporations, each of which offers several brands.
Physicians and pharmaceuticals - fees of doctors are prescribed by agreements between medical associations, health insurers and the government; prices of pharmaceuticals are fixed by producers.
Insurance contributions for car insurance and health insurance - prices are high and seem to be set by collusive agreements.
V. Modern Value Theory
Chapter 21 – Question 9
Modern value theory offers three explanations of price. Please list them.
* (1) Demand theory and price theory state that price equals marginal utility. (2) Price theory offers a second explanation: Prices reflect abundance or scarcity. (3) Supply theory postulates that price equals marginal cost.
Chapter 21 – Question 10
What is the revolutionary aspect of modern value theory?
* It has turned value into a subjective, volatile and relative property.
Chapter 21 – Question 11
Explain the paradox of value.
* It consists in the fact that water, which is indispensable, is cheap, while diamonds, which are more or less superfluous, are expensive. It was solved by the concept of marginal rather than absolute utility. Water is abundant; its price must be lowered to sell the last drop.
VI. An Excursus on Pre-Modern Value Theory
Chapter 21 – Question 12
Why did Aristotle think that making profits is "unsound and unnatural"?
* Because there is no natural limit in them while what is needed for a good life is limited.
VII. An Excursus on the Relationship between Price Theory and Profit Theory
Chapter 21 – Question 13
Marx said that profits are theft. What is stolen?
* Unpaid labour.
Chapter 21 – Question 14
What would neo-classical economists answer to the Marxian reproach?
* They would say that all workers are paid the same wages, which are the equivalent of the marginal product of the last worker hired. The marginal product of previously hired workers is higher than that of the last one. The higher marginal product of these workers is due to the fact that they work with a higher quantity of capital. Their higher marginal product is therefore a return to capital.
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