Evaluating a Policy Intervention in an Unstable Market
Based on the principles of price dynamics in a market with strong positive feedback, evaluate the likely effectiveness of the advisor's proposed one-time tax. Will it achieve the goal of stabilizing the price at its original, lower level? Justify your reasoning.
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Figure 8.12: Positive Feedback, Instability, and the Start of a Price Bubble
Analyzing Market Stability
Consider a market where the price in the next period is determined by the price in the current period. The relationship is such that for every $1 increase in the current price above its equilibrium level, the price in the next period increases by $1.20. If the price is currently 5% above its equilibrium level, what is the most likely outcome for the price in the subsequent periods, assuming no other market changes?
Consider a market where the price is at an unstable equilibrium. If a minor, temporary supply surplus causes the price to fall slightly below this equilibrium point, the market's internal dynamics will cause the price to self-correct and return to the original equilibrium level.
The Mechanics of Price Instability
Match each description of a market's price adjustment process with its corresponding characteristic or outcome.
The Dynamics of Market Instability
In a market characterized by an unstable equilibrium, a positive feedback mechanism ensures that any initial price deviation from the equilibrium level will cause a subsequent price change that is ______ in magnitude than the initial deviation.
A market for a specific asset is at an unstable equilibrium. A sudden, small increase in demand causes the price to rise slightly. Arrange the following events in the logical sequence that describes the resulting positive feedback loop.
Imagine a market where the price in one period determines the price in the next. This relationship is plotted on a graph with the current period's price on the horizontal axis and the next period's price on the vertical axis. A 45-degree line on this graph represents a constant price. In this specific market, the curve showing the price relationship is steeper than the 45-degree line. If a small, temporary event causes the price to move slightly away from the point where the curve and the 45-degree line intersect, what is the most likely outcome?
Evaluating a Policy Intervention in an Unstable Market