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Microeconomics Question from Walter E. Williams:Edit

Write brief answers explaining each of the following:

  • (a) Explain what Hayek might mean when he asserts that: "The most significant fact about the price system is the economy of knowledge with which it operates."
  • (b) Why does specialization lead to a larger output? What is meant by specialization in this context?
  • (c) If two people work jointly in production, it is impossible to tell who produced how much. What then is the meaning of the statement that each gets paid according to what he produces?
  • (d) Give at least three reasons why the observation of a negative rate of interest is highly improbable.

AnswerEdit

  • (a)Prices convey all relevant knowledge and ignore all irrelevant info for production decisions. It is relevant for such decisions that relative prices have changed, but irrelevant why. In this sense, it conveys only what is required, nothing which is superfluous. (Knowledge is cheaply imbedded in the price.)
  • (b)In a 2-person market, specialization allows individuals to leverage their competitive advantage in producing a good in order to exchange their excess production with others. In the real world, specialization is found in companies embedded in the concept of division of labor, which allows firms to increase output, taking advantage of economies of scale.
  • (c) WEW-048
  • (d)Generally speaking, people have a positive time preference, meaning they prefer goods sooner rather than later. A negative interest rate violates this precept. Additionally, for there to be negative interest rates people must value the future more than the present. Third, nominal interest rates have a positive inflation component allowing seigniorage for the fiat-loving government. Fourth, interest rates allow for the pricing of maturity risk…a time-based risk.

A negative inflation rate implies:

  • 1) future consumption is preferred to present consumption;
  • 2) lenders are willing to pay people to borrow their money;
  • 3) contingent consumption is preferred to assured consumption (risk preferred to certainty)

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