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1 Solution of Economics HW1 Fall Term Draw a circular-flow diagram. Identify the parts of the model that correspond to the flow of goods and services and the flow of dollars for each of the following activities. 2. Imagine a society that produces military goods and consumer goods, which we ll call guns and butter. 1

2 a. It is bowed out because the opportunity cost of butter depends on how much butter and how many guns the economy is producing. When the economy is producing a lot of butter, workers and machines best suited to making guns are being used to make butter, so each unit of guns given up yields a small increase in the production of butter. Thus, the frontier is steep and the opportunity cost of producing butter is high. When the economy is producing a lot of guns, workers and machines best suited to making butter are being used to make guns, so each unit of guns given up yields a large increase in the production of butter. Thus, the frontier is very flat and the opportunity cost of producing butter is low. b. Point A is impossible for the economy to achieve; it is outside the production possibilities frontier. Point B is feasible but inefficient because it is inside the production possibilities frontier. c. The Hawks might choose a point like H, with many guns and not much butter. The Doves might choose a point like D, with a lot of butter and few guns. d. If both Hawks and Doves reduced their desired quantity of guns by the same amount, the Hawks would get a bigger peace dividend because the production possibilities frontier is much flatter at point H than at point D. As a result, the reduction of a given number of guns, starting at point H, leads to a much larger increase in the quantity of butter produced than when starting at point D. 3. Classify the following topics as relating to microeconomics or macroeconomics. a. Microeconomics because Susan is an individual decision maker. b. Macroeconomics because national saving and economic growth are economy-wide phenomena. c. Microeconomics because these are specific markets. d. Macroeconomics because both are economy-wide phenomena e. Microeconomics because McDonald s is an individual decision maker in a specific market. 2

3 4. Classify each of the following statements as positive or normative. Explain. a. Positive because it is a statement of fact that can be tested. b. Normative because it is a statement of opinion that cannot be tested. c. Normative because it is a statement of opinion that cannot be tested. d. Positive because it is a statement of fact that can be tested. e. Normative because it is a statement of opinion that cannot be tested. Presumably, those that are buying cars are of the opinion that the price is too high. Those that are selling cars are of the opinion that the price is too low. 5. American and Japanese workers can each produce 4 cars a year. An American worker can produce 10 tons of grain a year, whereas a Japanese worker can produce 5 tons of grain a year. To keep things simple, assume that each country has 100 million workers. a. Amount produced per year (million) Car Grain America Japan b. America 3

5 6.Suppose that there are 10 million workers in Canada and that each of these workers can produce either 2 cars or 30 bushels of wheat in a year. a. Because a Canadian worker can make either 2 cars a year or 30 bushels of wheat, the opportunity cost of a car is 15 bushels of wheat. Similarly, the opportunity cost of a bushel of wheat is 1/15 of a car. The opportunity costs are the reciprocals of each other. b. c. From the figure above, Point B shows the outcome of trade proposal between two countries. Since Canada now consumes 200 million bushels of wheat which is greater than the amount consumed before and keep consuming 10 million cars as before, it is definitely better off. It should accept the deal. 7. The following table describes the production possibilities of two cities in the country of Baseballia: Pairs of Red Socks Per worker per hour Pairs of White Socks Per worker per hour Boston 4 2 Chicago 2 1 5

7 d. False; to be good for both parties, the trade price must lie between the two opportunity costs. e. False; trade that makes the country better off can harm certain individuals in the country. For example, suppose a country has a comparative advantage in producing wheat and a comparative disadvantage in producing cars. Exporting wheat and importing cars will benefit the nation as a whole, as it will be able to consume more of both goods. However, the introduction of trade will likely be harmful to domestic auto workers and manufacturers. 7

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