Chapter 3 cont. invisible hand

Chapter 3 cont. invisible hand - Chapter 3 Invisible Hand...

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Chapter 3 Invisible Hand Principle The Role of Prices and Profits The Role of Speculation The Role of Competition
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The Price-Equalization Principle q The tendency for free markets to establish a uniform price for the same good throughout the world , allowing for transaction costs (e.g., transportation costs and tax differentials). q Markets are globally interconnected q Price differences offer profit opportunities Price arbitrage – taking advantage of price differences: “buy low—sell high” (speculation)
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Illustration Raleigh Greensboro Transaction costs= $5 $85 $60 Before arbitrage $75 $70 After arbitrage The same type of jogging shoe: An entrepreneur could take advantage of the price difference by buying a truckload in Greensboro and delivering them. Consider the effect of a tax difference of $1 on a pair of shoes. Do your own “unit pricing” out there in the real world! Remember to consider goods homogeneous in every respect (allow for differences).
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International scope of the principle The price-equalization principle applies internationally with respect to tradable commodities. For example, consider crates of cherries: Rio de Janeiro, Brazil Traverse City, Michigan Transaction costs = $10/crate $220 $180 Before arbitrage $205 $195 After arbitrage
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Price-equalization Principle q An extremely powerful principle q Same existential status as the law of gravity q Explains why there is a lack of soaring prices or famine in the event of a severe crop failure. q A crop failure (supply decrease) puts upward pressure on food prices. q When prices exceed (what?), food supplies flow in from abroad to mitigate price increases Crop failure in France inflow
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Price-equalization-thru-time Principle q The tendency to establish a uniform price for the same storable good thru time. q Price differences thru time = profit opportunity q Speculation & Equilibrium: Again, price arbitrage or taking advantage of the profit opportunities (that is, speculation) eliminates price differences thus the profit opportunity. q Allowing for storage and interest costs q Important role of speculation: Smooth out consumption thru time!!!. ..important role
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How does the P-E-T principle work? How does speculation smooth out
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This note was uploaded on 04/01/2012 for the course ECON 101 taught by Professor Balaban during the Fall '07 term at UNC.

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Chapter 3 cont. invisible hand - Chapter 3 Invisible Hand...

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