ECON 500 Fall Exam #1 - Answer Key.

Transcription

1 ECON 5 Fall 24. Exam #1 - nswer Key. 1. uppose you have won $1 in a football pool. You are deciding between the following two options: I. spending the money now on a nice dinner for two at a fancy seafood restaurant (which would cost exactly $1) II. putting the entire sum of money away for exactly one year in a bank account that pays 4% interest. What is the true cost of the dinner at the seafood restaurant? Clearly explain. (1 points) The "true cost" of the dinner at the seafood restaurant is "what must be given up in order to get the dinner." If the $1 were put in a bank account that pays 4% interest for exactly one year, you will have "$14 one year from now." Thus, the "true cost" of the dinner at the seafood restaurant is "$14 one year from now." 2. Imagine a society that produces military goods ( guns ) and consumer goods ( butter ). The roduction ossibilities Frontier for guns and butter is illustrated below. Guns H U I D utter a. In the figure above, identify a point that is impossible for this economy to achieve (label this point U ). In the figure above, identify a point that can be achieved, but is inefficient (label this point I ). (4 points) b. uppose the society has two political parties, the Hawks (that want a strong military, but still some consumer goods) and the Doves (that want a smaller military, and more consumer goods). In the figure above: identify

2 a point that the Hawks might argue in favor of (label this point H ); identify a point that the Doves might argue in favor of (label this point D ). (4 points) c. uppose that an aggressive neighboring country reduces the size of its military. s a result, both Hawks and Doves reduce their desired level of Guns by the same amount. Which party would realize a bigger peace dividend, measured by the resulting increase in butter production. Clearly Explain. (4 points) The opportunity cost of butter is lower at point H than at point D. s a result, for a common decrease in the amount of guns, the increase in butter will be larger starting at H as opposed to starting at D. Thus, the "peace dividend" is larger for "Hawks" than for "Doves.". Consider a market in which upply and Demand are respectively given by the inverse functions ( q) = 2q and D ( q) = 24 q. a. Determine the functional form of D ( p). ( points) 1 D( p) = 8 p b. Determine the number of units that consumers are willing and able to purchase at a price of $ per unit. ( points) t a price of $ per unit, consumers are willing and able to purchase D ) = 8 1 () = 8 1 = 7 units. (

3 c. uppose upply Changes so that the new inverse supply function is new ( q) = 4q. Graphically illustrate upply both before and after this change. Does this change correspond to an Increase in upply or a Decrease in upply? Clearly explain. (4 points) new initial Q The change in upply illustrated above is clearly a Decrease in upply, since for any positive price, the corresponding quantity is less along the new upply Curve than along the initial upply Curve. 4. Clearly explain why each of the following statements is either correct or incorrect. (6 points each) a. "If the price of oil increases (with all other factors fixed), demand must decrease." This statement is incorrect, since a change in price (with all other factors fixed) will result in a change in quantity demanded, not a change in demand. b. "Dennis has a voucher from outhwest irlines (with no expiration date) for 'one free round trip ticket, anywhere outhwest flies in the continental United tates.' The true cost of using this voucher to fly to Las Vegas is zero, since he doesn't have to pay any money to obtain the ticket." This statement is incorrect, since by using the ticket Dennis has to give up "flying to his favorite destination other than Las Vegas." ince he does have to give something up in order to get the ticket to Las Vegas, the cost of the ticket to Las Vegas is not zero.

4 c. "When deciding how much to study for an exam, you should always increase your 'study time' if doing so increases your expected grade on the exam." This statement is incorrect, since a rational decision maker should not only "think on the margin," but should be sure to consider both "marginal benefits" and "marginal costs." The statement above considers only "marginal benefits." 5. Nick and Chris devote each workday to producing either apples or bananas. On any given day Nick can produce either 8 pounds of apples or 16 pounds of bananas, while Chris can produce either 6 pounds of apples or pounds of bananas. a. ased upon the provided information, which individual has an absolute advantage in the production of apples? Explain. (4 points) Nick has an absolute advantage in the production of apples, since he can produce a greater quantity in a given day ( 6 8 > ). b. ased upon the provided information, which individual has an absolute advantage in the production of bananas? Explain. (4 points) Without knowing the value of, it is not possible to determine which individual has an absolute advantage in the production of bananas. If < 16, Nick has an absolute advantage in the production of bananas; if > 16, Chris has an absolute advantage in the production of bananas. c. pecify a value of for which Chris has a comparative advantage in the production of apples. Justify your answer. (6 points) C N 16 OC = 6 and OC = 8 = 2. Chris has a comparative advantage in the C N production of apples when OC < OC, which is true for any < 12. d. In general, is it ever possible for one individual to simultaneously have a comparative advantage in the production of both apples and bananas? Clearly explain. (4 points) In general, this is not possible. egin by supposing that Chris has a comparative advantage in the production of apples, in which case C N C 1 N 1 OC < OC. Recall that OC = and OC C =. o, if Chris N OC OC has a comparative advantage in the production of apples, it follows that 1 1 N C <. From here, OC C N < OC, implying that Nick must have a OC OC comparative advantage in the production of bananas.

5 6. a. tate the Law of Demand. (6 points) The "Law of Demand" states that, holding all other factors constant, there is an inverse relation between price and quantity demanded. b. If demand is given by the function D( p) = 8 p is the Law of Demand satisfied? Clearly explain. (4 points) Yes, if demand is given by D( p) = 8 p the "Law of Demand" is satisfied. To see this, observe that an increase in p will lead to an increase in p, and subsequently a decrease in 8 p. ince q = D( p), we see that there is an inverse relation between price and quantity demanded. 7. cott and rad devote each workday to producing either computers or pizza. On any given day cott can produce either 4 computers or 12 pizzas, while rad can produce either 8 computers or 16 pizzas. s a result, the opportunity cost of computers for cott is OC C =, while the opportunity cost of computers for rad is OC C = 2. uppose that trade can take place between these two workers. a. Determine the maximum number of computers that these two individuals can produce collectively. (4 points) 4+8 = 12. b. Which of these two individuals has a comparative advantage in the production of pizza? Explain. (4 points) OC = = and OC = =. ince OC < OC, cott has a OCC OCC 2 comparative advantage in the production of pizza.

6 c. Graph the daily roduction ossibilities Frontier for this two person economy. Clearly label each intercept, as well as the slope of this curve at each point. (6 points) 12 computers lope = OC 1 = 8 lope = OC 1 = pizza d. Is it possible for these two workers to collectively produce 1 computers and 9 pizzas in a single day? Clearly explain why or why not. (4 points) No. The initial production of pizza should be done by cott. He requires 1 4 of a day to produce 9 pizzas. With his remaining 4 of a day he can produce only 1 4 (4) = 1 computer. s a result, (when producing 9 pizzas) the maximum number of computers that can be produced is = 9 < 1. e. rgue that: Without specialization and trade, it is not possible for cott to consume computers and 4 pizzas and for rad to consume 5 computers and 8 pizzas. However, with specialization and trade these levels of consumption are possible. (4 points) Without specialization and trade: if cott produces 4 (4) = computers, he can only produce 1 4 (12) = pizzas; if rad produces 1 (16) = 8 pizzas, 2 he can only produce 1 2 (8) = 4 computers. Thus, the target consumption bundles are not possible. However, with specialization and trade: cott can spend all day making pizzas (producing 12 units) and rad can spend all day making computers (producing 8 units). fter producing these quantities, rad can give cott computers in exchange for 8 pizzas. s a result, cott is left with computers and 4 pizzas, while rad is left with 5 computers and 8 pizzas.