Exam 7: The Price System: Signals, Speculation, and Prediction

Markets are linked in unpredictable and creative ways by:

A U.S. manufacturer arranges to purchase parts from a German supplier for 500,000 euros in six months. The U.S. manufacturer is concerned that the dollar will depreciate against the euro, meaning the dollar cost of the 500,000 euros will rise. What should the U.S. manufacturer do?

A soybean farmer plants his crop today but he doesn't harvest it until next year when the soybean price could be quite different from today's spot price. To avoid the price risk the farmer can:

Prices are incentives for sellers.

Reference: Ref 7-4 (Table: The HP Stock Exchange) The HP Stock Exchange lets members of HP's sales team buy and sell shares that pay off when sales fall within a certain range. A typical security would pay out $1, if and only if future sales fell within the specific range of that share. Accordingly, the trading prices given in the table suggest that the probability of selling:

A wheat farmer plans to retire at the end of the growing season, or about three months from now, and take up the leisure activity of fishing. The farmer would like to purchase a $20,000 fishing boat from selling his last crop of wheat. It's possible that when the wheat is harvested in three months that its price will be lower than it is today and the farmer would be unable to afford the boat. How can the farmer hedge his risk against a drop in wheat prices?

If speculators expect the future price of a commodity to rise, they may decide to use the ―buy low, sell high‖ strategy where they buy the commodity at a low price today in order that they may sell it later when prices rise. How might their actions actually cause a self-fulfilling prophecy in the short run? Use a demand and supply graph in your answer.

Futures markets are used for speculation and rarely for reducing risk.

The central planning approach fails to achieve an optimal resource allocation because of information and incentives problems.

Suppose resources are directed through the actions of a central planner, who receives information on all the different uses of these resources. Why might sellers have an incentive to provide untruthful information to the central planner?

Economist Paul Heyne looked in the newspaper and found that in December of 1991 the price of wheat was $4.05 a bushel. The futures price for March 1992 was $3.87, the May price $3.64, the July price $3.33, September was $3.31, and the futures price for the following December was $3.51. What is the implication of these price trends?

Rising oil prices during the 1970s shifted flower production from California to Kenya. Which of the following answers explains this shift?

Ethanol is the active ingredient in alcoholic beverages, but it's also a good fuel that can be made from a variety of crops like corn or sugar cane. Show how each of the following events would affect the market demand and/or supply of ethanol, as well as the resulting effect on the price of ethanol. a. The price of oil skyrockets with sudden eruption of war in the Middle East. b. More parents are concerned about cavities in their children's teeth, resulting from eating candy bars. c. Alcoholic beverage consumption is declining over time due to increased health warnings.

Higher oil prices represent higher energy costs in general across the economy leading to increased use of bicycles and public transportation. Which answer best describes the idea that changes in one market can cause effects in previously unseen markets?

How can a futures contract mitigate exchange rate risk for an exporting firm?

Speculators who think that a war in the Middle East is likely will:

Reference: Ref 7-2 (Figure: Demand Curve Sections) Refer to the figure. The section of the demand curve labeled B represents the:

Suppose Chad believes that the price of oil will be higher in the future and buys an oil futures contract from Joe. The contract will give Chad the right to 1,000 barrels of oil at $50 per barrel to be delivered by Joe 30 months in the future. Which of the following statements is correct?

How can selling a futures contract mitigate agricultural risk for farmers?

Asphalt is the refined residue from crude oil. When gasoline prices are high, oil refiners pull every last drop of gasoline out of a barrel of crude. This would imply that higher gasoline prices mean a(n):