AP Macroeconomics Unit 1 Review Session Production Possibilities Curve, Absolute and Comparative Advantage, Opportunity Cost, and Marginal Analysis 1. Draw a PPC with linear opportunity cost. 2. Draw a PPC that illustrates the law of increasing opportunity cost. Use the figure below to answer Questions 3-6. 3. What is the opportunity cost of 1 unit of textiles in the US? In Portugal? US: 1T = 1W Portugal: 1T = 1/3W 4. What is the opportunity cost of 1 unit of wine in the US? In Portugal? US: 1W = 1T Portugal: 1W = 3T 5. Assume the two countries have identical resources. a. In which product does the US have an absolute advantage? In which product does Portugal have an absolute advantage? US: wine and textiles (both) Portugal: neither b. In which product does the US have a comparative advantage? In which product does Portugal have a comparative advantage? US: wine Portugal: textiles Fill in the table. Assume that with trade, each country specializes and exports ½ of its production. Without Trade With Trade (Production) With Trade (Consumption) Wine Textiles Wine Textiles Wine Textiles Portugal 20 30 0 90 50 45 United States 50 50 100 0 50 45 Total 70 80 100 90 100 90
6. What happens to total world output when countries specialize and trade? Total output increases. What is this called? Comparative advantage 7. For each of the following scenarios, describe the opportunity cost of each decision. a. Sarah considers two options for Saturday night: she can attend a concert that costs $10 per ticket or she can see a free movie. She attends the concert. Loses out on seeing the movie; gives up whatever she could have bought with the $10 b. A new firm debates paying $20,000 for the prime location versus $10,000 for another location. The firm estimates that it will eventually serve the same number of customers in either location, but that it will take six months before the suboptimal location provides the same outcome as the prime location. The firm purchases the $10,000 property. Firm gives up the additional businesses it would have gotten at the prime location during the first 6 months c. Jamie can either be an unpaid intern at a company or he can earn $2,000 working as a camp counselor. He takes the internship. Jamie incurs an opportunity cost of $2,000 because he is giving up his income to work as an intern. 8. The following table presents the possible combinations of study time available to Roberto this week as he prepares for his two midterms: economics and chemistry. Assume Roberto has 20 hours to study and that he will use all 20 hours studying economics and chemistry. Roberto currently plans to study 10 hours for economics and 10 hours for chemistry. *Remember: Opportunity cost measures what is given up! Hours of study time Hours of study time Grade in economics Grade in chemistry spent on economics spent on chemistry 0 20 60 90 5 15 70 85 10 10 80 75 15 5 86 73 20 0 90 70 a. If he alters his plan and studies 15 hours for economics, what is his opportunity cost? 2 points on chem exam b. If he alters his plan and studies 15 hours for chemistry, what is his opportunity cost? 10 points on econ exam c. If he alters his plan and studies 20 hours for economics, what is his opportunity cost? 5 points on chem exam 9. The country of Utopia produces two goods from its available resources and technology. The only resource that Utopia has is labor. It takes 3 hours to produce 2 widgets and 4 hours of labor to produce 1 gadget. Assume a linear PPC. a. Sketch the PPC for the country of Utopia. (Use 120 hours as your labor constraint and sketch your PPC based on this amount of time and labor. Measure widgets on the y axis.) Y-intercept is at 80 widgets. X-intercept is at 30 gadgets. b. What is the slope of your PPC? 8/3 c. What is the opportunity cost of producing an additional widget in Utopia? 3/8 gadget d. What is the opportunity cost of producing an additional gadget in Utopia? 8/3 widget 10. The country of Jonesville produces two goods from its available resources and technology. The only resource that Jonesville has is labor. It takes 2 hours of labor to produce a gadget and 5 hours of labor to produce a widget. For this question, assume that the PPC for Jonesville is linear. a. Sketch the PPC for Jonesville assuming that it has 120 hours of labor available. (slope = --2/5 or --.4)) b. What is the opportunity cost of producing an additional gadget? 2/5 widget
c. What is the opportunity cost of producing an additional widget? 5/2 gadget d. Suppose that Jonesville has 240 hours of labor available instead of 120 hours of labor. Does this affect the opportunity costs? Explain. No, this will shift out the PPC from the origin, but the slope (opp. cost) will stay the same. 11. The following table provides six possible production combinations that Smithtown can produce from its available resources and technology during this year. Assume that Smithtown produces only bicycles and tents from its available resources. Combination Bicycles Tents A 100 0 B 90 10 C 70 25 D 40 36 E 10 42 F 0 45 a. Sketch Smithtown s PPC. (Measure bicycles on the x axis for this example.) b. Suppose Smithtown is currently producing as combination C. If Smithtown chooses to produce at combination B, what is the opportunity cost of moving from combination C to B? 15 tents c. Suppose Smithtown is currently producing at combination C. If Smithtown choses to produce at combination D, what is the opportunity cost of moving from combination C to D? 30 bicycles d. Is Smithtown s PPC linear? Explain. No, convex. Smithtown s resources are not equally well suited to producing bikes and tents. Say Smithtown devotes all resources to bikes, not all of those resources are particularly useful to bikes. Smithtown can move some resources away from bikes to tents without significantly decreasing bike production. However, the more tents Smithtown chooses to produce, the more resources better suited for bikes will be used less productively. This specialization of resources results in a PPC that is bowed out from the origin. 12. There are two islands in the middle of the ocean, and these two islands produce fish and baskets. Big Island can produce either 100 fish per day and 0 baskets per day or 0 fish per day and 200 baskets per day. Big Island can also produce any combination of goods that lies on its linear PPC. Small Island can produce either 80 fish per day and 0 baskets per day or 0 fish per day and 80 baskets per day. Like Big Island, Small Island has a linear PPC. (Measure fish on the y axis.) a. Sketch the PPCs for Big Island and Small Island. b. What is the slope of Big Island s PPC? 1/2 Of Small Island s PPC? 1
c. What is the opportunity cost of producing an additional basket on Big Island? ½ fish On Small Island? 1 fish Which island can produce baskets at a lower opportunity cost? Big Island d. What is the opportunity cost of producing an additional fish on Big Island? 2 baskets On Small Island? 1 fish Which island can produce fish at a lower opportunity cost? Small Island e. What good should Big Island specialize in producing? Baskets What good should Small Island specialize in producing? Fish Positive and Normative Economics 13. Decide whether each of the statements is a normative statement or a positive statement. a. The gasoline tax is projected to yield $10 million in tax revenue next year. Positive b. If the gasoline tax were raised by 10 cents per gallon, tax revenue would increase by 4%. Positive c. The state should raise the gasoline tax for the coming year. An increase will reduce congestion and smog, which is more important than the cost to commuters. Normative d. Mandatory school enhances the work skills of students. Normative e. The age of mandatory school attendance should be extended. Normative f. An extension of mandatory school attendance will increase government education costs by $2 million for the state. Positive 14. Define positive economics and normative economics. Why does normative economics cause greater disagreement among economists? Positive: descriptive; objective; how world works. Negative: prescriptive; subjective; how world should work Economists may not share the same values and will reach different conclusions about how the world should work. Supply and Demand 15. Graph supply and demand curves, indicating equilibrium price and quantity on the axes. Draw a correctly labeled graph showing the effect on equilibrium price and quantity in the market for oranges when, ceteris paribus, each of the following changes occurs. a. There is a freeze in Florida that kills many of the orange groves. Top left b. The wages of orange workers decrease. Top right c. Research finds oranges have additional health benefits. Bottom left d. The price of tangerines decreases. Bottom right 16. The following chart shows the quantity demanded in the competitive market for bicycles.
Price per bicycle Quantity of bicycles demanded per week $100 0 80 100 60 200 40 500 20 800 0 1,000 a. Suppose the price is initially $40. If price rises by $20, what happens to the quantity demanded? Decreases by 300 b. Suppose the price is initially $40. If price falls by $40, what happens to quantity demanded? Doubles (increases by 500) 17. For each of the following scenarios (in the table below), fill in the missing information. Does that scenario cause a shift of or movement along the demand curve? If a shift occurs, does the demand curve shift to the right or left? Scenario Specified market Movement (M) or shift (S) Demand shift right (->) or left (<-) People s income increases Market for exotic vacations S People s incomes decreases. Market for goods sold in secondhand S shops Price of bicycles increases. Market for bicycles M Price of tennis balls increases. Market for tennis racquets S Price of movie tickets decreases. Popcorn at movie theater S Popularity of music playing device Market for music-playing devices S increases. Popularity of name-brand clothing Market for band-name designer S items decreases. clothing Winter clothing is expected to go on Market for winter clothing S sale next month. Number of urban residents increases. Market for apartments in urban areas S 18. The following graph represents the supply curve for the production of widgets in Town Center. a. At a price of $20, how many widgets are producers willing to supply? 40 widgets b. At a price of $40, how many widgets are producers willing to supply? 80 widgets c. Suppose there are ten widget producers in Town Center and the price of widgets is $50. If each producer produces the same number of widgets, how many widgets will each produce? 10 widgets d. Suppose price is initially $30 but then falls to $20. What is the change in quantity supplied? 60 to 40 e. Suppose price is initially $30 but then rises to $50. What is the change in quantity supplied? 60 to 100 f. What price must suppliers receive in order to be willing to supply 80 widgets? $40 g. What price must suppliers receive in order to be willing to supply 40 widgets? $20
h. How does the slope of a supply curve reflect the relationship between price and quantity supplied? Upward sloping/positive slope. Quantity supplied increases when price increases and quantity supplied decreases when price decreases 19. For each of the following scenarios (in the table below), fill in the missing information. Does that scenario cause a shift of or movement along the supply curve? If a shift occurs, does the supply curve shift to the right or left? Scenario Specified market Movement (M) or shift (S) Supply shift right (->) or left (<-) Labor costs for air travel and cruise Market for exotic vacations S ships increase. Prices of office equipment and phone Market for call center services S service rise by 40% Price of bicycles increases. Market for bicycles M Price of leather boots increases. Market for beef products S Price of leather boots increases. Market for leather belts S New technology for music players Market for music-playing devices S revealed. Price of brand-name designer clothing Market for brand-name designer M increases. clothing Number of coffee shop owners in the metro area increases. Market for coffee in the metro area S 20. The demand and supply schedules for Healthy Snacks, Inc., is provided in the table below. Price Quantity demanded Quantity supplied $0 1,000 0 10 800 125 20 600 275 30 400 400 40 200 550 50 0 675 a. Sketch the demand and supply curves for Healthy Snacks, Inc. Don t worry about being precise. Focus on drawing the relationships. b. Indicate equilibrium price and quantity. c. Fill in the following table based on the data given. (Hint: If there is excess in supply, there is no excess demand and vice versa.) Price Excess demand Excess supply Shortage or Surplus? $0 1,000 Shortage 10 675 Shortage 20 325 Shortage 30 Equilibrium Equilibrium --- 40 350 Surplus 50 675 Surplus 21. For each of the following scenarios, draw a correctly labeled graph showing the effect on equilibrium price and quantity when, ceteris paribus, each of the following changes occurs. Indicate initial market demand (D 1 ), supply (S 1 ), equilibrium price (P 1 ), and equilibrium quantity (Q 1 ) as well as any changes to the market demand (D 2 ), and/or supply (S 2 ) curves, and indicate the new equilibrium price (P 2 ) and quantity ( Q 2 ). a. The price of gasoline increases by 40 percent. What happens in the market for bicycles? D (Substitute good) b. The price of gasoline increases by 40 percent. What happens in the market for fuel-inefficient SUVs? D (complementary goods) c. New technology for music-playing is developed? What happens in the market for these devices? S d. The price of labor decreases. What happens in the market for fast-food restaurants? S e. Income increases and good X is a normal good. What happens in the market for good X? D f. Income increases and good X is an inferior good. What happens in the market for good X? D
Price Floors and Price Ceilings 22. Consider the market for housing in Metropolitan City, where all housing units are exactly the same. Currently, the equilibrium price of housing is $2,000 a month and local residents consume 1,500 units of housing. The local residents argue that housing is too expensive and an effective price ceiling is implemented. When the price ceiling is implemented by the local government council, only 1,200 units of housing are supplied. Is this an efficient level of housing for Metropolitan City? Explain and use a graph to show equilibrium quantity and price, as well as the price ceiling and the quantity supplied and quantity demanded after the price ceiling is implemented. 1200 is not an efficient level of housing consumers willing to pay more, but suppliers are restricted on how much they can receive. 23. Use the graph below to answer the following questions. a. What is the equilibrium price? Equilibrium quantity? P1, Q3 b. Suppose a price floor of P 3 is implemented by the government in this market. What will happen to the price and quantity once this price floor is implemented? Not effective price floor. P3 < P1 (equilibrium P&Q will not change) c. Suppose a price floor of P 2 is implemented by the government in this market. What will happen to the price and quantity once this price floor is implemented? Effective. P2 > P1. At P2, Q1 demanded and Q4 supplied; excess supply of Q4--Q1 (surplus) d. You are told that an effective price floor has been implemented in this market and the resultant surplus is greater than Q 4 -Q 1. What do you know about the level of this price floor? Price floor must be set at a price > P2 e. Where must be true for a price floor to be effective? Must be set at a price greater than the equilibrium price f. Suppose a price ceiling of P 2 is implemented by the government in this market. What will happen to the price and quantity once this price ceiling is implemented? Not effective price floor. P2 > P1 (equilibrium P &Q will not change) g. Suppose a price ceiling of P 3 is implemented by the government in this market. What will happen to the price and quantity once this price ceiling is implemented? Effective. P3 < P1. At P3, Q5 is demanded and Q2 is supplied; excess supply of Q5 Q2 (shortage) h. You are told that an effective price ceiling has been implemented in this market and the resultant shortage is less than Q 5 -Q 2. What do you know about the level of this price ceiling? Must be between P1 and P3 i. Where must be true for a price ceiling to be effective? Must be set at a price less than Pe
24. The market for taxi rides in Metropolitan City this week is described in the following table. Assume that all taxi rides are the same. Price of taxi rides Quantity of taxi rides demanded per week Quantity of taxi rides supplied per week $1 200 40 2 180 60 3 160 80 4 140 100 5 120 120 6 100 140 7 80 160 8 60 180 9 40 200 10 20 220 a. What is the equilibrium price and quantity of taxi rides in Metropolitan City per week? Equilibrium occurs when the quantity demanded equals the quantity supplied. b. Suppose the government institutes a medallion system that limits the number of taxi rides available in Metropolitan City to 80 per week. According to the data in the table, the equilibrium price is $5 and the equilibrium quantity is 120 taxi rides per week. At what price will consumers want to purchase 80 taxi rides per week? Consumers will demand 80 taxi rides per week at a price of $7 At what price will suppliers be willing to supply 80 taxi rides per week? Suppliers are willing to supply 80 taxi rides per week for a price of $3. What price will a taxi medallion rent for in this market? Explain. The medallion will rent for $4 per taxi ride, or the difference between the demand price and the supply price when the quantity of taxi rides is limited to 80 per week. c. Graph the taxi ride market in Metropolitan City. On this graph, indicate the equilibrium price and quantity, the quota limit, the demand price, the supply price, and the medallion s rental price. d. What is total value of the taxi medallions per week in Metropolitan City? The taxi medallions are worth the product of the medallion rent per ride times the number of taxi rides per week or ($4 per ride)(80 rides), or $320.