ECO 221 Fall Semester 2023 Homework Problem Set 4 Answers Coverage Chapters 31-34 in BBS ed 14 Instructor : Questions 10 Worth 40 Due Tuesday, April 7 at or before 11:59 pm Student Name: _______________________ Chapter 33 1. Show that if the economy’s aggregate supply curve is vertical, fluctuations in the growth of aggregate demand produce only fluctuations in inflation with no effect on output. Ans: When the economy is using all of its resources and running at maximum capacity, the aggregate supply curve is vertical. Since the economy can only produce as much as it can at this point, every increase in aggregate demand will only result in higher prices. In other words, a vertical aggregate supply curve prevents the economy from raising output in response to rising demand, which results in price variations (inflation) but not in levels of production. Thus, shifts in aggregate demand have no effect on output; instead, they simply affect changes in inflation. 2. It is often said that the Federal Reserve Board typically cares more about inflation and less about unemployment than the administration. If this is true, why might presidents often worry about what the Fed might do to interest rates? Ans: The dual goal of the Federal Reserve Board is to promote maximum employment and stable prices. However, because of the detrimental effects of excessive inflation, the Board places more emphasis on maintaining price stability than on resolving concerns about unemployment. Presidents, however, pay greater attention to unemployment rates since they are important gauges of the state of the economy and have a direct impact on the welfare of their constituents. Presidents are concerned about the Federal Reserve's interest rate decisions because they have a direct impact on borrowing, spending habits, and investment choices. The Federal Reserve's interest rate changes have the potential to affect economic growth, unemployment rates, and eventually the political standing of a president, raising questions about the health of the economy as a whole. Chapter 34 3. The following table describes the number of yards of cloth and barrels of wine that can be produced with a week’s worth of labor in England and Portugal. Assume that no other inputs are needed. In England In Portugal Cloth 8 yards 12 yards Wine 2 barrels 6 barrels a. If there is no trade, what is the price of wine in terms of cloth in England? Without commerce, one barrel of wine would cost four yards of cloth in England (i.e., two barrels of wine for every eight yards of cloth). b. If there is no trade, what is the price of wine in terms of cloth in Portugal? Without trade, one barrel of wine would be worth two yards of cloth (6 barrels of wine for every twelve yards of cloth) in Portugal. c. Suppose each country has 1 million weeks of labor available per year. Draw the production possibilities frontier for each country. The production possibilities frontier for any nation can be seen as a graph that illustrates the most permutations of wine and fabric that can be made using the labor force that is available. If Portugal's PPF were to show a steeper slope for wine production, it would indicate an absolute advantage in wine production; similarly, England's PPF would show a steeper slope for fabric. d. Which country has an absolute advantage in the production of which good(s)? Which country has a comparative advantage in the production of which good(s)? Portugal has a clear edge in the production of wine, but England has a clear advantage in the manufacturing of cloth. Portugal has a comparative advantage in wine production for the same reason that England has a comparative advantage in fabric manufacturing due to the lower opportunity cost of making cloth relative to wine. e. If the countries start trading with each other, which country will specialize and export which good? The nations would concentrate in producing the goods for which they have a competitive advantage if they began trade. Portugal would specialize in the manufacturing and export of wine, while England would produce and sell textiles. f. What can be said about the price at which trade will take place? The comparative advantage of each nation would be used to calculate the price of trade. Trade terms would probably be more in line with each nation's opportunity cost ratio, guaranteeing that both countries would gain from trade and specialization. 4. The Dutch settlers led by Peter Minuit, established in 1624, in Lower Manhattan New York an outpost. The outpost depended on the fur trade. Animal belts of beavers, bear, foxes, would be purchased from Indian tribes in exchanged for manufactured goods from Europe and most importantly guns. In May 1626, Minuti purchased the entire island of “Manhatta” from the Lenape Indian tribe for 60 Guilder, worth of trade goods (beads, mirrors, trinkets, and iron tools such as axes, knives, adzes) The 60 guilders are worth approximately$1143 in current US dollars. The West India Company which sponsored the New Netherland settlement wanted to secure the entire island for defensive purposes, so as to protect their burgeoning fur trading business from potential hostile Indian tribes and European rivals. As of 2020, the developable land of Manhattan is worth $1.9 trillion. Land in Manhattan is ranked the third most expensive in the world, behind Monaco and Hong Kong. The Lenape Indian tribe currently lives on a reservation in Oklahoma. Neoclassical economics holds that as long as trade is voluntary and there is full information, it will only occur if it yields mutual gain. Some believe that in trade, only one party wins and the other loses. A. How would you evaluate this exchange in 1626? Do you think it was fair? Do you think that mutual gain was derived? How can the neoclassical theory reconcile this transaction that with the passage of time looks like one party was seriously disadvantaged and the other did not benefit as much. Ans: The historical background of the Manhattan Exchange in 1626 must be taken into account when assessing the event. In exchange for 60 guilders' worth of trade goods, the Dutch settlers bought the island from the Lenape Indian tribe. The Lenape sold a rich tract of land for what is now regarded as a minimal and undervalued sum, which may seem unfair to modern eyes. But land ownership and value were not the same concepts back before, and it's possible that the Lenape did not view land in the same manner as the Europeans. B. In 1651 the British established a colony in present day Suriname. In 1667, the British and the Dutch exchanged colonies. The Dutch ceded Manhattan ( area 86.97 km2 ) to the British in exchange for the vast territory of Suriname(163, 820 km2), that lies on the northeast coast of South America. Suriname is natural resource rich country ( gold, diamonds, oil, gas, bauxite, timber, agricultural lands). Suriname at the time was a plantation colony producing sugar, rice, and indigo with African slave labor. Was this a fair exchange in your opportunity in your personal opinion? Is it fair if you use ahistorical neoclassical economic approach? Ans: In the case of the exchange of Manhattan for Suriname in 1667 between the British and the Dutch, the transaction involved different territories with varying natural resources and economic potential. Suriname was a plantation colony rich in resources such as gold, diamonds, oil, and agricultural lands, but it relied on African slave labor. Manhattan, on the other hand, was a valuable trading post. Given that Suriname uses slave labor, the trade of Manhattan for that country could be seen as unethical from a moral or ethical perspective. Neoclassical economic theory, which emphasizes voluntary exchange, would, nevertheless, view this transaction as fair if both parties consented to it voluntarily and thought it would advance their interests in terms of resource acquisition and economic expansion. 1.
