Econ 226 Principles of Microeconomics Fall, 21 Dr. Kathryn Wilson Due Date: Thursday, September 13 th Homework 1 Answer Key 1. At Bob s grill, Bob cooks corn on the cob and ribs. For each hour that Bob grills, he can make either 8 ears of corn or 4 slabs of ribs. Bob grills 8 hours each day. Graph Bob s production possibilities frontier for a day where he works 8 hours. See below. Bob's Production Possibilities Frontier 7 65 6 55 5 45 Ears of Corn 4 35 3 25 2 15 1 5 5 1 15 2 25 3 35 4 Slabs of Ribs Suppose Bob is currently producing 4 ears of corn and 12 slabs of ribs. What is the opportunity cost of producing another slab of ribs? Explain. We find the opportunity cost by taking the slope of the production possibilities frontier (PPF). Since the PPF is a straight line, we can choose any two points. Using the endpoints, the slope = (64 ) ( 32) = 64-32 = -2. The opportunity cost of one more slab of ribs is 2 ears of corn. Suppose Bob is currently producing efficiently (somewhere on the production possibilities frontier). Does Bob s opportunity cost of producing another slab of ribs depend on his current location on the production possibilities frontier? Does he have increasing opportunity costs? Explain. The opportunity cost does not depend on where they are on the ppf. Since the ppf is a straight line, the slope is the same everywhere. No matter how many slabs of ribs Bob is making, the opportunity cost of one more is 2 ears of corn. Give two examples of things that would shift Bob s production possibilities frontier out. (Be specific to things that would shift the frontier for grilling corn and ribs). Examples will vary, but
they should deal with an increase in resources (such as a larger grill) or increase in technology.
2. The following graph shows the production possibilities frontier for a woodworker who makes wooden picture frames and wooden candle stick holders. Woodworker's Production Possibilities Frontier 6 55 5 New PPF with rap music 45 4 B A candle stick holders 35 3 25 C 2 15 1 5 1 2 3 4 5 6 7 8 9 1 picture frames What is the opportunity cost of 1 more picture frame if the woodworker is currently making 4 picture frames? If the woodworker is making 4 picture frames and wants to increase to 5 picture frames, he/she must go from 45 to 4 candle stick holders. In other words, 5 candle stick holders are given up to get one more picture frame so the opportunity cost is 5. Does the woodworker have increasing opportunity costs? How do you know? Yes, the woodworker does have increasing opportunity costs and we know because the PPF is a curve. The slope of the PPF tells the opportunity cost and since the slope of a curve changes depending on where you are on the curve, the opportunity cost of picture frames changes depending on how many picture frames are being made. For example, the opportunity cost of going from to 1 picture frame is about 1 candle stick holder while the opportunity cost of going from 9 to 1 picture frames is 1 candle stick holders. Draw three points on the graph where point A is unattainable, point B is efficient, and point C is attainable but inefficient. See the graph.
Suppose the woodworker learns that by listening to rap music while carving wood, she can carve both candle stick holders and picture frames more quickly. Draw a new production possibilities frontier to reflect this. This implies the woodworker can produce more and shifts out the PPF.
3. The following two graphs show the production possibility frontiers for the United States and Mexico in the production of automobile parts and computer software. United States Mexico Software 1 9 8 7 6 5 4 3 2 1 2 4 6 8 1 12 14 16 18 2 Auto Parts Software 2 18 16 14 12 1 8 6 4 2 1 2 3 4 5 6 7 8 9 1 Auto Parts What is the opportunity cost for one more auto part for the United States? For Mexico? The opportunity cost is the slope of the ppf. For the United States, this is 5; for Mexico, this is 2. For every auto part made, the United States must give up 5 software while Mexico gives up 2. What country has an absolute advantage in making auto parts? What country has an absolute advantage in making software? What does absolute advantage mean? A country has an absolute advantage when it can produce more of a good than the other country with the same quantity of resources. The United States has the absolute advantage in making auto parts since they can make as many as 9 while Mexico can only make as many as 18. The United States also have the absolute advantage in auto parts as they can make twice as many as Mexico (18 compared to 9). What country has a comparative advantage in making auto parts? What country has a comparative advantage in making software? What does comparative advantage mean? Comparative advantage means a country can produce a good at a lower opportunity cost. We found above that the opportunity cost of one auto parts is 5 software for the U.S. and 2 for Mexico. Mexico has a lower opportunity cost, so they have a comparative advantage in making auto parts. Since Mexico has a comparative advantage for auto parts, we know the U.S. has one for software. Which of the following statements is true? Explain why it is true. If the U.S. and Mexico trade, only the country with absolute advantage can gain. If the U.S. and Mexico trade, only the country without absolute advantage can gain. If the U.S. and Mexico trade, both countries can gain. The third statement is true. We learned that through focusing on what each country has a comparative advantage in making, both countries can gain from trade. What are the terms of trade. In other words, what is the most and the least number of software that will be traded for each auto part? Since the opportunity cost of an auto part for the U.S. is 5 software, the most they are willing to give up is 5 software for each auto part (if Mexico demanded more, the U.S. would just make auto parts themselves instead of trading). Since the opportunity cost of an auto part for Mexico is 2 software, the least they are willing to accept is 2 software for each
auto part (if the U.S. offered less than 2 software for each auto part, Mexico not trade). Thus, anywhere between 2 and 5 software for each auto part would be the terms of trade. Give an example of a possible trade that would make both countries better off. Make sure you indicate which country is making each product. Mexico should make auto parts since it has a comparative advantage and the U.S. should make software. Any trade that fits the terms of trade above would work. For example, one possible trade is 15 software for 5 auto parts. 4. Last fall the U.S. was considering extending permanent normal trading rights to China. a. Based on the economic theory, discuss whether or not you think the U.S. can gain by trading with China and why. The economic theory suggests that both the U.S. and China can gain from more free trade. There are some goods the U.S. has a high opportunity cost of making (they must give up a lot to make these goods) while China has a low opportunity cost of making. This is true regardless of who has an absolute advantage in producing each product. By focusing on products that the U.S. has a comparative advantage in and allowing China to produce products they have a comparative advantage in, the U.S. can gain from trading and so can China. b. Discuss at least three factors that may make us want to limit trade with China. There are a variety of possibilities. One might be national security. If the U.S. feels their national security will be compromised if a lot of goods they use are produced in China, they might want to limit trade (particularly if they think we might ever go to war with China, in which case we don t want to be too dependent on China). A second possibility is that for political reasons we might want to limit trade. For example, many people argue that China has human rights violations that the U.S. does not approve of and thus we will limit trade with China to punish them (although we must realize the U.S. also gets punished by such an arrangement). A third possibility is in order to protect jobs in certain industries. While the U.S. as a whole may gain from trade, there may be some individuals who lose their jobs and are harmed. We must recognize, though, that protecting these jobs comes at a cost to American consumers. c. What response would you give to a person who says, If we have free trade with China, I will lose my job. Therefore, we shouldn t trade with China.? Answers will vary. It is certainly true that some people may lose their jobs. In aggregate, though, we expect other new jobs to open up. If we are able to retrain people for these new jobs, the person who loses his/her job may only temporarily be out of work. As mentioned above, while the U.S. as a whole may gain from trade, there may be some individuals who lose their jobs and are harmed. We must recognize, though, that protecting these jobs comes at a cost to American consumers. 5. The following table shows the demand and supply for video rentals at Video 11. Draw a graph of the demand curve and supply curve. (Make sure you label your axis.) Quantity Quantity Price Demanded Supplied $ 5 $.5 45 5 $1. 4 1 $1.5 35 15 $2. 3 2 $2.5 25 25 Price $5.5 $5. $4.5 $4. $3.5 $3. $2.5 $2. $1.5 $1. $.5 $. 1 2 3 Quantity S 4 D 5
$3. 2 3 $3.5 15 35 $4. 1 4 What is the equilibrium price and quantity? The equilibrium is where supply and demand cross a price of $2.5 and a quantity of 25. If the price of videos were $3.5, would there be a shortage or surplus? How big would it be? There would be a surplus. Suppliers would be willing to sell 35 but consumers only willing to buy 15. This leaves a surplus of 35 15 = 2. 6. What would be the effect of the following on the demand curve, the supply curve, equilibrium price, and equilibrium quantity of baseball hats that say KSU Football? (Note: you don t need any numbers just draw a simple graph showing how the curves would shift and write what would happen to price and quantity.) i. The football team goes undefeated for the season and wins the national championship. Change in taste shifts demand out. Price increases and so does quantity. P S D ii. The taxpayers in Ohio decide college should be free and give all KSU students a refund of their tuition. This is like an increase in income for students. If hats are a normal good, demand would shift out and price and quantity would rise. If hats P S are an inferior good, demand would shift in and price and quantity would fall. I have drawn the D graph as if they are a normal good (which I think is true in this case). iii. A major hurricane hits the south and wipes out the cotton plants (assuming the hats are made out of cotton). This is an increase in input prices, which shifts the supply curve in. The price goes up and the quantity goes down. P S iv. The price of Ohio State Football baseball hats goes up. Q Q Q D
OSU hats are a substitute for KSU hats. If the price of OSU hats goes up, people will buy less OSU hats and instead buy KSU hats so the demand curve for KSU hats would shift out. Price and quantity would both rise. The graph is the same as i and ii.