a. A professor devotes 20 years of his life trying to determine the most efficient form of social insurance programs.

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1 ECO 110 Introduction to Economics Professor Mike Rizzo First COLLECTED Problem Set SOLUTIONS This is an assignment that WILL be collected and graded. Please feel free to talk about the assignment with your friends or with your group and others and I would like for you to submit your assignment as a group. Please note the names of all group members on the assignment, as well as the time that your class meets (i.e. 11:30 or 1:50). Assigned: Due: Monday, February 20 th Wednesday, March 1 st 1. Briefly (1-2 sentences each) provide a purely self-interested explanation for each of the following kinds of behavior. You do not have to believe your explanation is correct. (credit to Bryan Caplan) ANSWER: This question is asking you to think about the nature of human preferences selfishness. At the most abstract level, economists make no assumptions about what preferences have to look like. In practice, however, economists almost always make the strong assumption that people are almost entirely selfish. They place vastly more weight on the well-being of themselves and their family than they do on the well-being of strangers. Why do economists assume this? Simply put, because it is basically true! What percentage of their disposable income do people spend on themselves? Evolutionary interpretation: unselfish beings would not have survived. However, what economists take with one hand they give back with the other: Selfish people will often treat other people very well. Why? It is often in your interest to be nice to other people! Take for example why your waiter or waitress is nice to you! Thus, selfish intentions may still produce cooperative results (both the waiter and you are happy). Recall the classic statement in the movie Wall St. "Greed is good." This distinction between intentions and results frequently appears in economics. Exceptions to selfishness: aren't there a lot of counter-examples? Family-based examples don't count - evolution does select for concern for blood relatives. Friendship etc. might count - but almost invariably these relations involved reciprocity - you scratch my back, I'll scratch yours. Still, there remain plenty of examples where people help strangers who have no prospect of ever returning the favor it just makes them feel good. a. A professor devotes 20 years of his life trying to determine the most efficient form of social insurance programs. b. Bill Gates gives computers to needy children. c. Bill Clinton tells an audience that "he feels their pain." 1

2 d. Someone does Christmas collections for the Salvation Army. e. You give your friend a ride to the airport. 2. In the wild, wolves are often seen peacefully sharing the same water source (lakes, rivers, etc.) - no growling, no sniping, no complaints the wolves silently tolerate each other. However, this is emphatically NOT the case when one wolf stumbles upon another as it sets down to consume its kill. In most cases, wolves will growl and snipe until the other leaves, but in some cases the situation devolves into a fierce fight. Why the difference in behavior? After all, water is just as essential for life as is food. Indeed, because a wolf can live a good deal longer without a meal than he or she can live without water, water arguably is more important than food. (credit to Don Boudreaux) ANSWER: For some reason, wolves behave as if they have an understanding of marginal thinking they would be able to answer the water-diamond paradox! Water is much more readily available for wolves than food. Therefore, the is not much gain to a wolf by threatening physical violence to another wolf that shares its water, but there would be much to gain from threatening physical violence to another wolf that tried to share its food. In other words, each available unit of food was worth more to wolves than was each available, comparably sized unit of water. Hence, wolves genes are evolved to prompt them to be willing to spend more risking life and limb by threatening violence to protect a food source than they are programmed to spend to protect an equally sized source of water. 3. Briefly (1-2 sentences each) use marginal analysis to explain the following (credit to Bryan Caplan): ANSWER: Looking at constraints strategically, you can see that constraints create incentives for certain kinds of behavior rather than others. Probably the best illustration of how to think strategically about incentives is what economists call marginal analysis. What is marginal analysis? It consists in considering the effects of small changes on outcomes. Often, people reason: writing articles is important for tenure, so I should write articles; or, doing hw is important for getting a good final grade, so I should do all of my hw. But this doesn't follow. The real question is not: Should I write at all, but how much should I write? I might have so few articles that I have no chance for tenure. Then the marginal benefit of writing another article is zero. Alternately, I might have so many publications that I'm a shoe-in. Then again, the marginal benefit of writing another article is zero. There are many applications of marginal analysis and you should use them to rephrase the questions below. These applications include: marginal 2

3 happiness, marginal benefit, marginal cost, marginal productivity, marginal impact on probability of success, etc. a. Why tenured professors at Harvard usually keep working hard, but tenured professors at lower-ranked schools often do not. The marginal benefits to doing so are much higher at Harvard. This is because these professors need to maintain their reputations and this will allow them greater job mobility and wage bargaining power. The economic returns at lower ranked schools are not nearly as high. b. Why I don't brush my teeth after a long plane flight. I am so exhausted that the best use of my next 10 minutes of time is to get into bed and not brush my teeth. c. Why students often quit working in a class if they get 100% on the midterm. The right question is how much I need to study to get a given grade, say a B. Once you ve aced a midterm, the marginal benefit of spending lots of time preparing for future exams is much lower than before I got the 100%. d. Why you are more likely to speed when other drivers are already speeding. The marginal cost of speeding is much lower when everyone is speeding than if I am the only one speeding just think of the probability of being caught. e. Why anyone orders just one pizza from Pizza Hut. (When you buy one pizza at Pizza Hut, the second is half price!) Because you don t get as much satisfaction from eating slices 9-16 than you do from slices 1-8. Some people get enough satisfaction to buy that second pizza, but many do not. 4. Over the next five or ten years, hundreds of millions of Chinese are expected to leave the Chinese countryside and move to the city. This extraordinary migration will require millions of adjustments to take place to make sure that our lives here in America are not thrown totally out of whack. All those newly-arrived Chinese city dwellers will use more pencils, drink more coffee, buy more bicycles, and buy more cars and so on. Will there be enough to go around for those of us outside of China? Surely this expected migration will cause immense disruption. Should we worry about it? What precautions should we take to make that transition a smooth one? (credit to Russell Roberts) To help you answer this question, it would be helpful to think about the answer to the following two questions: 3

4 i. Do you know when (and how large) the greatest migration in human history occurred? (Answer: it was the migration of 100 million people from Chinese countryside to cities from ii. When this happened, did the Chinese buy up all the bicycles or cedar for the pencils or coffee grounds for more coffee, leaving us with none? ANSWER (quoting from Roberts): And yet, like Bastiat's Parisian, we rightly lose little or no sleep worrying about these changes. The transition will be managed not by a Congressional committee or Presidential board charged with averting a crisis. The transition will be handled by the price system and we'll hardly notice it. Part of the reason for my confidence is based on my theoretical understanding of how markets work as Hayek describes them. But much of my confidence comes from the evidence of the past 20 years when a hundred million Chinese made the same trek we're talking about in the future. This is the greatest migration in human history and my guess is that you missed it. Very little changed in the world around us. The Chinese didn't buy up all the bicycles or cedar for the pencils or coffee grounds for more coffee. Somehow, our economic system took care of this transition so effectively, that most of us didn't even know it happened. One of Hayek's favorite quotes was from Adam Ferguson on the result of human action but not of human design, Mankind, in following the present sense of their minds, in striving to remove inconveniences, or to gain apparent and contiguous advantages, arrive at ends which even their imagination could not anticipate, and pass on, like other animals, in the track of their nature, without perceiving its end... Every step and every movement of the multitude, even in what are termed enlightened ages, are made with equal blindness to the future; and nations stumble upon establishments, which are indeed the result of human action, but not the execution of any human design. [From An Essay on the History of Civil Society (1767): Part Third. Section II, p. 122 of the Duncan Forbes edition, Edinburgh University Press, An online edition is at McMaster's.] Such changes are happening all the time. The price system, along with the profit we allow producers to earn for responding effectively to prices, keeps our economic lives orderly in the face of those changes. Teachers of economics, this one included, should be looking for ways to illuminate the unseen workings of that incredible system. It is a system that is often described as competitive. Yet it is ultimately a system of cooperation. No one designed the system. It works without anyone being in charge. Marvel at it. 5. Many Americans routinely drive their own cars to work rather than use public transportation or form a car pool. a. How do you know that each person in a single-passenger vehicle during the rush hour is behaving efficiently? 4

5 Economic theory assumes that everyone is behaving efficiently. We infer the values that drivers in single-passenger vehicles place upon inputs and outputs by seeing how they behave. Of course, people do make mistakes (except for me) and then look back at what they have done and see that it was inefficient. But, it was an efficient action at the time, when the actor had less adequate information. It is sometimes costly and therefore inefficient to acquire additional information before deciding. b. The people riding the bus are also behaving efficiently. How can (a) and (b) both be true simultaneously? Whether because of differences in situation or differences in character and temperament, the people riding the bus assign different relative values to certain inputs and outputs. Remember what economists mean by efficiency it is people taking actions that FOR THEM the additional benefits exceed the additional costs and these costs and benefits include pecuniary as well as non-pecuniary costs. c. What is actually being asserted by someone who says that it s inefficient for so many commuters to take their own cars to work? d. Such critics are assigning evaluative weights to the inputs or outputs of other people s actions DIFFERENT from the weights assigned by the actors themselves. They might be objecting to the costs (air pollution, traffic congestion) that drivers impose on others and ignore in their decision making (we ll learn more about this later in term); they may be claiming that drivers of single-passenger vehicles are misinformed in some way; they may simply be asserting implicitly that their own values are superior to the values of such drivers. Of they may be saying that if transactions costs did not exist or if they had all knowledge and power they could arrange a social world in a way more satisfactory to everyone but who could not? 6. Airlines are willing to overbook flights because they know that some people who make reservations do not always show up. Sometimes, however, this results in more people holding reservations at the gate than there are seats on a flight. a. Is overbooking efficient from the airlines perspective? Overbooking enables the airlines to hold down the number of empty seats and to sell more passengers the seats they ask for. 5

6 b. Is overbooking efficient from the standpoint of the passengers? Passengers are able to get on flights they want to take and from which they would have been excluded, despite empty seats, under a policy of no overbooking (or differential pricing). c. As a consequence of a 1976 court case that Ralph Nader won against an airline that had bumped him, the federal government adopted a rule requiring airlines to compensate people who were denied boarding despite holding a confirmed reservation. As a result, the airlines started to ask for volunteers who were willing to take a later flight whenever a flight turned out to be overbooked. Who benefited from this new regulation? Under the new system, passengers in a hurry (who proved how valuable their time was by arriving at the airport shortly before their flight) always get on their flight; passengers not in a hurry get money for taking a later flight; airline agents at the gate avoid nasty arguments with passengers who are being bumped; the airlines continue the efficient practice of overbooking, and don t reap the wrath of valuable passengers who have involuntarily denied boarding. It almost seems as if everyone is better off. 7. Specialization and free trade within our country is fine. But free international trade is another beast altogether. Cheap foreign imports do not increase our nation s production possibilities frontier and create economic growth. Instead, cheap imports create a loss of jobs in our country. Carefully evaluate this statement. To help you with your discussion, it might be useful to remember that trade occurs between individuals and not counties, cities, states, etc. It might also help you to think about the difference between improved competition from companies within America (e.g. Southwest Airlines versus U.S. Air; or Amazon.com versus local bookstores) versus from companies outside America (e.g. software writers in India versus in Silicon Valley). ANS: As we emphasized in class, trade is always between individuals, as opposed to streets, cities, counties, states or nations. Neither a national political border nor a time-zone boundary within a given country negates the mutually beneficial effects of voluntary trade. Both trading parties enjoy a larger mix of scarce goods (greater wealth and economic growth) as a result; that s WHY they choose to trade with one another across political borders. Millions of Americans purchase foreign goods, but that fact does not necessarily mean that EVERY citizen in each country is better off. Cheap foreign imports are attractive to many individuals in America. Those individuals increase their wealth through such purchases. To the extent that cheaper imports lead consumers to buy fewer American produced substitutes, some of 6

7 those workers (and business owners) may lose their jobs (and their businesses) as they now fail to provide customers with a desirable product. But that is true whether the source of competition is from a foreign country or from within our country. To understand this point, let s suppose you now have access to an American internet bookstore, one that offers superior prices and service compared to the local old-fashioned bookstores in your region. (Compared by WHOM? The customers.) They win customers from the other local establishments, even forcing one or more to shut down. Clearly the local bookstore owners and employees haven t gained by the increased competition. Clearly their wealth has not increased as customers seek to trade with OTHERS who now offer a better substitute. But that s a large part of the nature of market competition the attempt to provide consumers with a better product or service, and/or a more appealing price. Consumers are constantly on the watch for a better, more attractive deal. That s why, to take another recent example, traditional American-made typewriters have been replaced by and large with American-made personal computers (when this all started). A free market process nationally and internationally allows potential producers the opportunity to create more desirable options for consumers. It doesn t guarantee that ALL or even MOST existing producers will always enjoy profits and continued job expansion. If production is simply a goal in itself, the alternative seems to be to keep consumers from obtaining the products they desire elsewhere. We could imagine, for example, a domestic policy that forces consumers to continue using typewriters as opposed to wordprocessors. That might retain jobs in the typewriter industry, but it would REDUCE job prospects in the software and personal computer industry (not to mention stifling the enormous technological advancement that has resulted from personal computing). Similarly, import restrictions (in the form of quotas and taxes on foreign goods) might preserve some jobs in the U.S., but it would ultimately reduce job prospects for U.S. citizens (such as wheat farmers) whose goods are exported to other countries. 8. Pick a current issue that is a hot topic in the news, in the sports world, on campus, etc. Describe the issue in microeconomic terms. Then describe the issue in macroeconomic terms. 9. Recall the exercise we went through in class on Friday, February 17 th. Suppose Mike has initially bid $0.90 for the dollar that was for sale. He is then outbid by Rachel, who bids $1.04. Would it be rational for Mike to bid $1.05 to secure the dollar? That is, is it rational to bid $1.05 just to win back $1.00? Explain, using the basic principles we learned about in class. Yes, it is entirely rational, because Mike understands the difference between sunk costs and marginal costs. Economic decisions should be made based on marginal benefits and costs, not total benefits and costs. In this example, no matter what Mike does, the 90 cents is lost it is a sunk cost. So, his decision 7

8 about whether to bid more for the dollar should NOT take this into account. The marginal cost of bidding $1.05 is actually only 15 cents! This is the additional cost he would incur by making the bid ($1.05 $0.90). If he thinks that there is a good chance to win the dollar, then this bid is rational. If he wins the dollar, his total losses would be $0.05. If he does not bid and therefore loses the auction, his total losses would be $0.90. So, the net marginal benefits from bidding $1.05 (if he wins) would be $ Consider the following statement by Professor Meg A. Lomaniac: I started here in the Fall of 2004 and there were 160 students enrolled in economics courses. In the Spring of 2006, there are 400 students enrolled in economics courses. I should remind the Dean of this fact when he makes his decisions for raises this year. Identify the economic error that Meg is making with her comment. You can actually identify this as one of three errors, but I prefer to think of this as an error confusing correlation with causation. Just because these two events coincided (Meg s arrival and an explosion in enrollments), does not mean Meg s arrival caused this explosion. It might be the case that other programs are suffering in quality at the same time. It might be the case that the curriculum requirements changed. While Meg s evidence is persuasive, her confidence in its truth should be tempered somewhat. 11. I have showed you a good number of statistics in class that indicate how much the standards of living in the U.S. have increased over time. Yet, many of you remain unconvinced that things are getting better. One thing you constantly hear about is that Americans are overworked and the reason why America is more prosperous (in dollar terms) than its European counterparts is simply because we work more. In fact, Charles McGrath (7/3/05) wrote a recent piece in the Sunday NY Times Magazine ( No Rest for the Weary ) singing this exact song. For this question, I want you to determine whether in fact the typical American enjoys more or less leisure than he enjoyed during the alleged halcyon days of the 1960s and 1970s. Please describe the findings and cite the source of the data. For those of you that do not want to look for statistics, a recent paper by Mark Aguiar and Erik Hurst answers just this precise question. For those of you that want to look for statistics, I suggest the Bureau of Labor Statistics or the Economic Report of the President. Why do you think this myth is perpetuated? Does the fact that we are enjoying more leisure mean we are getting less done today than we did 30 years ago? Why or why not? Here is the abstract to the paper I reference above: 8

9 In this paper, we use five decades of time-use surveys to document trends in the allocation of time. We document that a dramatic increase in leisure time lies behind the relatively stable number of market hours worked (per working-age adult) between 1965 and Specifically, we document that leisure for men increased by 6-8 hours per week (driven by a decline in market work hours) and for women by 4-8 hours per week (driven by a decline in home production work hours). This increase in leisure corresponds to roughly an additional 5 to 10 weeks of vacation per year, assuming a 40-hour work week. We also find that leisure increased during the last 40 years for a number of sub-samples of the population, with lesseducated adults experiencing the largest increases. Lastly, we document a growing inequality in leisure that is the mirror image of the growing inequality of wages and expenditures, making welfare calculation based solely on the latter series incomplete. (my emphasis added to the end) So, Americans are not overworked (though I feel like I am). The other thing missing in this study is that the authors ignored the biggest leisure gainers in the population the growing number of retired persons. They excluded anyone over 65 years of age. So, folks, if time is money, we are even richer than I have been telling you we are. Had you chosen the Economic Report of the President you would have found the following: Average hours worked per week for private production and non-supervisory workers in the United States: Now it could be the case that for some groups, such as professionals, supervisors, self-employed, hours of work have risen. And perhaps some surveys have been taken of these groups show a rise in hours worked. However, even for this group, lifetime hours worked have been falling for two reasons, earlier retirement and less time really working on the job. The latter point is that even when we're "working" that is, sitting at our desk, we take leisure, making airline reservations for our vacation, bidding on ebay. This inconvenient fact of falling rather than rising hours of work makes the logic in the Times article a bit difficult to sustain. The author has been asked 9

10 by other economists for the source for the claim that people are working more hours and has yet to respond by sending the data. That we have more time does not mean we are lazy, but is rather a reflection of our ability to produce more goods and services in a given time period today than we were able to some 20 or 30 years ago. I can promise you that this trend will only continue (just think of the advances in home technologies that are on the way infinitely long lasting siding and paint, self washing walls, timed blinds and HVAC systems, self-clog removing pipes, etc.). As for why this myth continues to be perpetuated, I ll leave it to your imagination to determine. 12. In your online readings I assigned an article by Tyler Cowen called, The Future of Culture in a Globalised World. a. In an answer to the question, What does it mean to be truly New Zealand in cultural terms, how does he respond? b. What does this have to do with the material we covered thusfar in the course (think back to your first paper assignment)? c. What role does he suggest that government can play in promoting in an increasingly globalized world? d. Why is he skeptical of government spending on arts for purposes of national identity? Answers directly in the paper. 13. Does the fact that teachers are paid less than athletes mean that society values then less than athletes? Explain, using an example if possible. People who believe that our priorities are mixed up are confusing total value with marginal value. It is most certain that the total value of teachers to society is much larger than the total value of athletes. It s just that the value of the last athlete to society is larger than the value of the las teacher to it. And this is because relative to teachers, the skills and aptitudes of athletes are much more scarce and that people in society are willing to pay to enjoy these attributes. When we get to supply and demand, you will notice this distinction as being the difference between the total area beneath the demand curve versus the point on the demand curve that the supply curve crosses it. 14. Treasury Secretary John Snow tries to make the case for the Bush tax cuts that lowered the tax on capital. He states that the Bush tax cuts were good for the economy, After nine consecutive declining quarters of real annual business investment, we have had 10 straight quarters of 10

11 rising business investment. The turning point, he says, corresponds with the timing of the investment tax cuts. He appends the following picture to his comments: What errors are committed in this statement and accompanying figure? As I see it, there are two problems (ignore the fact that there are 8 negative bars instead of the 9 cited above). First, take away the dotted line and it should be clear to you that there is a longer upward trend happening, so it might be merely coincidental that the tax cuts happened and the trend ticked to positive percentage changes. Second, you'd really want to know when the tax cuts took force. You might expect the behavioral changes the tax cuts induced to begin before the tax cuts took effect and maybe even before the signing people anticipate changes all of the time. Now if the signing or the implementation coincided with what looks like the 3rd quarter of 2001, then at least the picture would complement the claim that the tax cuts had driven the improvement in the business climate. Finally, while it might be true that the tax cuts spurred investment growth, so many other factors are operating in the economy that to attribute changes in investment to one factor alone (albeit an important one) is a bit simplistic and misleading. 11

12 15. Describe the economic principle that is being demonstrated by this piece of news: This piece nicely illustrates the principle of unintended consequences. Many of us are asked to conserve heat in the winter by turning down the thermostat (and I applaud since I LOVE cold weather). However, in doing so, workers have been found to be LESS productive. So, while you might save some money on your electricity bill (as intended), you might actually be losing money overall due to lost output at work (as was not intended). You might find this to be an acceptable tradeoff, but in the long run these measures will not encourage people to have the wealth to invest in cleaner and more efficient ways of heating their homes. 16. Mankiw, Chapter 3, Problem # 2. a.see Figure 2. If Maria spends all five hours studying economics, she can read 100 pages, so that is the vertical intercept of the production possibilities frontier. If she spends all five hours studying sociology, she can read 250 pages, so that is the horizontal intercept. The time costs are constant, so the production possibilities frontier is a straight line. Figure 2 b. It takes Maria two hours to read 100 pages of sociology. In that time, she could read 40 pages of economics. So the opportunity cost of 100 pages of sociology is 40 pages of economics. 12

13 17. Mankiw, Chapter 3, Problem # 4. a Pat's opportunity cost of making a pizza is 1/2 gallon of root beer, since she could brew 1/2 gallon in the time (2 hours) it takes her to make a pizza. Pat has an absolute advantage in making pizza since she can make one in two hours, while it takes Kris four hours. Kris' opportunity cost of making a pizza is 2/3 gallons of root beer, since she could brew 2/3 of a gallon in the time (4 hours) it takes her to make a pizza. Since Pat's opportunity cost of making pizza is less than Kris's, Pat has a comparative advantage in making pizza. b. Since Pat has a comparative advantage in making pizza, she will make pizza and exchange it for root beer that Kris makes. c. The highest price of pizza in terms of root beer that will make both roommates better off is 2/3 of a gallon of root beer. If the price were higher than that, then Kris would prefer making her own pizza (at an opportunity cost of 2/3 of a gallon of root beer) rather than trading for pizza that Pat makes. The lowest price of pizza in terms of root beer that will make both roommates better off is 1/2 gallon of root beer. If the price were lower than that, then Pat would prefer making her own root beer (she can make 1/2 gallon of root beer instead of making a pizza) rather than trading for root beer that Kris makes. 18. Mankiw, Chapter 3, Problem # 7. a. English workers have an absolute advantage over Scottish workers in producing scones, since English workers produce more scones per hour (50 vs. 40). Scottish workers have an absolute advantage over English workers in producing sweaters, since Scottish workers produce more sweaters per hour (2 vs. 1). Comparative advantage runs the same way. English workers, who have an opportunity cost of 1/50 sweater per scone (1 sweater per hour divided by 50 scones per hour), have a comparative advantage in scone production over Scottish workers, who have an opportunity cost of 1/20 sweater per scone (2 sweaters per hour divided by 40 scones per hour). Scottish workers, who have an opportunity cost of 20 scones per sweater (40 scones per hour divided by 2 sweaters per hour), have a comparative advantage in sweater production over English workers, who have an opportunity cost of 50 scones per sweater (50 scones per hour divided by 1 sweater per hour). b. If England and Scotland decide to trade, Scotland will produce sweaters and trade them for scones produced in England. A 13

14 trade with a price between 20 and 50 scones per sweater will benefit both countries, as they'll be getting the traded good at a lower price than their opportunity cost of producing the good in their own country. c. Even if a Scottish worker produced just one sweater per hour, the countries would still gain from trade, because Scotland would still have a comparative advantage in producing sweaters. Its opportunity cost for sweaters would be higher than before (40 scones per sweater, instead of 20 scones per sweater before). But there are still gains from trade since England has a higher opportunity cost (50 scones per sweater). 19. Mankiw, Chapter 3, Problem # 8. a. With no trade, one pair of white socks trades for one pair of red socks in Boston, since productivity is the same for the two types of socks. The price in Chicago is 2 pairs of red socks per pair of white socks. b. Boston has an absolute advantage in the production of both types of socks, since a worker in Boston produces more (3 pairs of socks per hour) than a worker in Chicago (2 pairs of red socks per hour or 1 pair of white socks per hour). Chicago has a comparative advantage in producing red socks, since the opportunity cost of producing a pair of red socks in Chicago is 1/2 pair of white socks, while the opportunity cost of producing a pair of red socks in Boston is 1 pair of white socks. Boston has a comparative advantage in producing white socks, since the opportunity cost of producing a pair of white socks in Boston is 1 pair of red socks, while the opportunity cost of producing a pair of white socks in Chicago is 2 pairs of red socks. c. If they trade socks, Boston will produce white socks for export, since it has the comparative advantage in white socks, while Chicago produces red socks for export, which is Chicago's comparative advantage. d. Trade can occur at any price between 1 and 2 pairs of red socks per pair of white socks. At a price lower than 1 pair of red socks per pair of white socks, Boston will choose to produce its own red socks (at a cost of 1 pair of red socks per pair of white socks) instead of buying them from Chicago. At a price higher than 2 pairs of red socks per pair of white socks, Chicago will choose to produce its own white socks (at a cost of 2 pairs of 14

15 red socks per pair of white socks) instead of buying them from Boston. 15