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I.
Three University of Chicago Nobelists and their Contributions to Economic Science and
Policy
The Royal Swedish Academy of Science announces the Bank of Sweden Prize in
Economics in honor of Alfred Nobel every October to recognize the specific
achievements of a living economist to the field of economics. Although Nobel prizes are
often awarded to co-winners (in which the prize for that year is shared), each year an
effort is made to recognize path-breaking contributions to economic science. For
instance, the 2001 prize was awarded to George Akerloff, Michael Spence, and Joseph
Stiglitz for their research into the area of asymmetric information.
In this Internet exercise, we will look at three important Nobel prizewinners in economics
who were trained at and remain closely associated with the University of Chicago: Milton
Friedman, George Stigler, and Gary Becker. First read George Mason professor Charles
Rowley's essay about these that appeared in The Independent Review, an economics
journal published by The Independent Institute, a free market-oriented think tank based in
California.
a) What does Rowley consider to be "the worst intellectual mistake" of Milton
Friedman's career? Why does Rowley consider this a mistake?
b) For what reason did the Nobel committee award Friedman the Nobel Prize in
1976?
c) Now go to Milton Friedman's Homepage at the Hoover Institution at Stanford
University. What emphases in public policy economics have been important to
him in addition to his scientific research?
d) Now return to the Rowley essay, and skip ahead to the section on George Stigler.
Why was Stigler's 1938 doctoral dissertation hailed as an important contribution
to the history of economic thought?
e) For what reason did the Nobel committee award Stigler the Nobel Prize in 1982?
What area does Rowley believe is central to almost all of Stigler's research?
f) Now go to Stigler's biography at the Library of Economics and Liberty, which is
maintained by the Liberty Fund. What is the significance of Stigler's 1962 paper
on electricity regulation?
g) Now return to the Rowley essay, and skip ahead to the section on Gary Becker.
For what reason did the Nobel committee award Becker the Nobel Prize in 1992?
h) What is the economic approach consistently deployed by Becker (according to
Rowley)? What does Becker assume to be the fundamental constraint faced by all
economic actors?
i) Now go the Gary Becker's autobiography at the Nobel e-Museum. What was the
whole range of family issues that Becker studied as embarked on his research into
the economics of the family? How does Becker view the way his research has
been received by the economics profession?
II.
Given the products below and the events that affect them, indicate what happens
to demand or supply, and the equilibrium price and quantity. Identify the
determinant of demand or supply that causes the shift.
(a) Blue jeans. The wearing of blue jeans becomes less fashionable among
consumers.
(b) Computers. Parts for making computers fall in price because of
improvements in technology.
(c) Lettuce. El Nino produces heavy rains that destroy a significant portion of
the lettuce crop.
(d) Chicken. Beef prices rise because severe winter weather reduces cattle
herds.
In the spaces below each of the following, indicate the [increase (+), decrease (–
), or indeterminate (?)] on equilibrium price (P) and equilibrium quantity (Q) of
each of these changes in demand and/or supply.
P
Q
(e) Increase in demand, increase in supply
__________ _________
III.
(f) Increase in demand, decrease in supply
__________
_________
(g) Decrease in demand, decrease in supply
__________
_________
(h) Decrease in demand, increase in supply
__________
_________
a) What does each of the following statements imply about the price elasticity of
demand?
1. I always spend $100 on widgets whether the price rises or falls.
2. I always buy 100 widgets whether the price rises or falls.
b) If a firm wants to maximize revenue, at what point on the demand curve should its
price be?
c) If you know that a good is inferior, what do you know about its income elasticity?
Do you know if it is elastic or inelastic?
d) Consider the elasticity of demand for three different goods: gasoline, diamonds,
and food.
1. The short-run elasticity of demand for gasoline is estimated to be about 0.11,
but the long-run elasticity is about 0.9. Explain, based on the determinants of
elasticity, why the short-run elasticity is so low (inelastic), but why elasticity is
far higher (though still inelastic) in the long run.
2. We would expect the elasticity of demand for diamonds to be very high
(elastic). Give at least two reasons why.
3. The income elasticity of demand is estimated to be approximately 1. If your
income rises by 10%, how much more will you spend on food? How would
income elasticity be expected to be different for specific food categories such as
bread and chocolate? What about price elasticity?
IV.
Web Exercise.
Visit the web site of the Center for Disease Control
(http://www.cdc.gov).
Search for the facts on price elasticity of demand
for cigarettes. How are the estimated elasticities used by policy analysts?
As the old adage says, “Time is money.”
1. Consider two activities. You like both equally well (that is, each gives you the
same marginal utility per unit). Both cost the same amount. Activity A takes 2
hours; Activity B takes 4 hours.
a. Use the principle of opportunity cost to explain why these two goods do not
have the same cost, although their prices are identical.
b. All other things equal, how should you allocate your time between these two
activities?
2. Many of the inventions of the last 50 years are specifically designed to save
time.
a. Assuming that all prices remain constant, what has happened to the consumer’s
budget set? Show this graphically.
b. Despite the existence of many time-saving devices (consider, for example,
how long it takes to prepare dinner today relative to a century ago), people seem
to be constantly complaining about having not enough time. How this paradox
can be explained?
Consider a person who spends a total of $200 on hats and violets. The price of
hats is $20, and the price of violets is $5. Draw the budget line, with hats on the
horizontal axis and violets on the vertical axis.
a. What is the slope of the budget line?
b. Draw an indifference curve that intersects the budget line. Explain why the
consumer can reach a higher utility level than the level shown by this indifference
curve.
c. Draw a second indifference curve at the highest possible utility level.
V.
A. Long-run price adjustment in competitive industries depends on the cost
structure
of the industry. The following three cases describe competitive
industries. In each case, graph the approximate shape of the long-run supply
curve and indicate
what will happen to the price of the product in the short run
and the long run in response to the market change described.
Case 1. The housing industry uses a large amount of materials such as wood, and
thus industry expansion tends to drive up lumber costs. Income growth causes an
increase in the demand for new homes.
Case 2: The ice cream stand industry uses many inputs, such as unskilled labor
and milk, which are in plentiful supply. Demand for ice cream cones increases in
the summer.
B. You’ve been hired by an unprofitable firm to determine whether it should shut
down its unprofitable operation. The firm currently uses 70 workers to produce 300
units of output per day. The daily wage (per worker) is $100, and the price of the
firm’s output is $30. The cost of other variable inputs is $500 per day. Although
you don’t know the firm’s fixed cost, you know that it is high enough that the firm’s
total costs exceed its total revenue. Should the firm continue to operate at a loss?
VI.
In cities, over time, there will tend to be many shopping malls, all of which have
virtually identical stores in them.
a. Why is this an example of a monopolistically competitive industry with
differentiated products?
b. Use graphs to show a short-run and a long-run equilibrium in this industry.
c. What do consumers gain from having a large number of nearly identical
shopping malls? What do they lose? Do you think that there are the optimal
number of malls in your area?
VII.
Suppose that you are thinking about attending business school. Your education
will cost $15,000 per year, and you expect to receive your BA degree in four years.
Suppose you expect that your earnings will be $5,000 per year higher than they would
have been had you gone to work immediately after high school. Assume that the interest
rate is 10% and your working life expectancy is 20 years. Is the decision to attend
business school justified as an economic investment? Identify the factors that could
change the judgment about business school as an invetment.