1. According to Figure 1.1, what is the opportunity cost of increasing consumer output from OF to OD?

Transcription

1 Solutions to Problem set 1 (chp 1 Q1-7 / chp 3 Q3-7) 28 possible points Chapter 1 1. According to Figure 1.1, what is the opportunity cost of increasing consumer output from OF to OD? In figure 1.1, the move from OF to OD along the consumer goods axis moves the economy from point X to point C on the production possibilities curve. As a result, the economy must give up G minus E (1 point) military goods.

2 2. Draw a production possibilities curve based on Table 1.1, labeling combinations A-F. What is the opportunity cost of producing 100 missiles? Production Possibilities Curve Quantity of Houses A B C D E F Quantity of Missiles The opportunity cost of producing 100 missiles is a reduction in the production of houses from 100 to 75, or a loss of 25 houses.

3 3. Assume that it takes 4 hours of labor time to paint a room and 3 hours to sand a floor. If all 24 hours were spent painting, how many rooms could be painted by one worker? If a decision were made to sand two floors, how many painted rooms would have to be given up? Illustrate with a production-possibilities curve. Production Possibilities Curve 10 Floors Sanded Rooms Painted If all 24 hours were spent painting, it would be possible to paint a total of six rooms (24/4 = 6). If you wanted to sand two floors, it would take a total of six hours (3 hours per floor x two floors). In these six hours, you could have painted 1½ rooms, thus the opportunity cost of sanding two floors is not paining 1½ rooms

4 4. Suppose in problem 3 that a second worker became available. Illustrate the resulting change in production possibilities. Now what would be the opportunity cost of sanding two floors? Production Possibilities Curve Floors Sanded Rooms Painted Assuming the second worker is as productive as the first, a doubling of the labor input allows you, in 24 hours, to paint and sand twice as many rooms and floors. The opportunity cost of sanding two floors, however, has remained unchanged. Opportunity cost is the value of what you must give up in order to do the next best thing. Even though you now have two workers, the opportunity cost of sanding two floors for either worker is still 1½ floors.

5 5. According to Figure 1.3, what is the cost of a war that increases military output from M 2 to M 1? What is the opportunity cost of maintaining military output to M 1? If military output increases from M 2 to M 1, then the decrease in output of consumer goods is reduced from C 2 to C 1. The opportunity cost of maintaining military output at M 1 is the amount of consumer goods forgone. At point S, there are many millions of men and women on active military duty and additional millions of civilians employed by the Department of Defense or military contractors. All of this labor and other resources could be used to produce consumer goods or public works. (1 point total for either answer)

6 6. On a single graph, draw production possibilities curves for 1945 and 2005 with consumer goods and military goods as the output choices. Label points A and B to approximate the choices. made in each year (see Figure 1.2 for data). B 2005 Consumer Goods. A 1945 Military Goods Figure 1.2 suggests that, as a percentage of GDP, total military output was higher in 1945 than in Thus, as suggested by point A, in 1945 the U.S. made a choice to produce a relatively high level of military goods (nearly 40 percent). Since 1945 the U.S. economy has grown, as demonstrated by an outward shift of the PPC, and military output as a percentage of GDP has declined, to around 4 percent, as illustrated by point B.

7 7. Assume that the table on the next page describes the production possibilities confronting an economy. Using that information: a. Draw the production-possibilities curve. Be sure to label each alternative output combination (A through E). b. Calculate and illustrate on your graph the opportunity cost of building one convenience store per week. c. What is the cost of producing a second convenience store? What might account for the difference? d. Why can t more of both outputs be produced? e. Which point on the curves is the most desired one? How will we find out? Potential Weekly Output Combinations Homeless Shelters A 10 0 B 9 1 C 7 2 D 4 3 E 0 4 Convenience Stores a. Production Possibilities Curve Convenience Stores E D C B A Homeless Shelters b. The opportunity cost of producing the first convenience store is reducing the production of homeless shelters from 10 to 9, or 1 homeless shelter. c. The opportunity cost of producing the second convenience store is to reduce the production of homeless shelters from 9 to 7, or 2 homeless shelters.

8 d. It is not possible to produce more of both outputs because resources are scarce. Thus, assuming that all resources are efficiently used, i.e., we are on the production- possibilities curve, to produce more convenience stores requires taking resources from the production of homeless shelters, and vice versa. To produce more of both would require either finding more resources or developing new technology that allows for existing resources to be used more efficiently, i.e., the production-possibilities curve would shift outward. e. With the available information, it is not possible to tell which point is the most desired. This point depends on the tastes and preferences of the society that is producing the items. In general, the combination that is most desired is that combination which offers the most amount of satisfaction for consumers while maximizing profits for producers. This point will be discovered through the interaction of market forces.

9 Chapter 3 3. Given the following data, (a) construct market supply and demand curves and identify the equilibrium price; and (b) identify the amount of shortage or surplus that would exist at a price of $4. Participant Quantity Supplied (per week) Price $5 $4 $3 $2 $1 Supply Side Alice Butch Connie Dutch Ellen Market Total Participant Quantity Demanded (per week) Price $5 $4 $3 $2 $1 Demand Side Al Betsy Casey Daisy Eddie Market Total Supply and Demand Price (per unit) $6 $5 $4 $3 $2 $1 $ Quantity (per week) (a) Equilibrium price is $2. Demand 1 Supply Demand 2 (for problem #4) (b) At a price of $4, there would be a surplus of 9, the difference between the market quantity supplied of 19 and the market quantity demanded of 10.

10 4. Suppose that the good described in problem 3 became so popular that every consumer demanded one additional unit at every price. Illustrate this increase in market demand and identify the new equilibrium. Which curve has shifted? Along which curve has there been a movement of price and quantity? The market demand curve will shift to the right by 5 units at every price. Given this new demand curve, the new equilibrium will be approximately $3.50 and 17 units. The increase in price results in a movement along the supply curve, resulting in an increase in quantity supplied.

11 5. Illustrate each of the following events with supply or demand shifts in the domestic car market: a. The U.S. economy falls into a recession. b. U.S. autoworkers go on strike. c. Imported cars become more expensive. d. The price of gasoline increases. Price S2, part b S1 D1 D3 D2, parts a and d Quantity (a) This would result in a decrease in demand (leftward shift of the demand curve) due to a decline in buyer income. (b) This would result in a decrease in supply (leftward shift of the supply curve) due to reduced ability to produce output. (c) This would result in an increase in demand (rightward shift of the demand curve) as consumers substitute relatively less expensive domestic cars for the now relatively higher priced imported cars. (d) This would result in a decrease in demand (leftward shift of the demand curve) due to a higher price of a complementary good, gasoline.

12 6. Show graphically how the release of Strategic Petroleum Reserves would affect gasoline prices and consumption (see Headline on p. 71). Supply Supply 2 P 1 P 2 Demand Q 1 Q 2 Quantity (gallons per day) Release of Strategic Petroleum Reserves would increase the supply of gasoline available, leading to lower gas prices and more consumption, ceteris paribus.

13 7. Assume the following data describe the gasoline market. Price per gallon $ Quantity Demanded Quantity Supplied a. What is the equilibrium price? b. If the quantity supplied at every price is reduced by 5 gallons, what will the new equilibrium price be? c. If the government freezes the price of gasoline at its initial price, how much of a surplus or shortage will exist when supply is reduced as described above? d. Illustrate your answers on a graph. a. The equilibrium price is $1.50 where Q s =Q d. b. If the quantity supplied at every price is reduced by 5 gallons, the new equilibrium price would be $1.75. c. If the government freezes the price of gasoline at its initial price of $1.50, the reduction in supply will result in a shortage of gasoline of 5 gallons (24 19). Supply and Demand Price per gallon Supply 2 Supply 1 Demand Quantity