Econ 301 – F07
PROBLEM SET 1 - due in class on Tuesday September 11
Wissink
1. Argentina and Brazil both produce leather and coffee with labor. The labor input is measured in
hours, coffee is measured in gallons and leather is measured in yards. The table below shows labor
requirements to produce a unit of coffee and of leather in each country. (It is assumed that the labor
requirements per unit of output in production remain the same irrespective of the quantity of the two
goods produced.) Each country has 120 hours of labor available, which can be allocated between the
two activities. Labor can not go from one country to the other but coffee and leather can.
HOURS
REQUIRED
1 gallon of
coffee
1 yard of leather
Argentina
Brazil
10 hrs
15 hrs
4 hrs
20 hrs
a. Graph the production possibilities frontier (PPF) for both Argentina and Brazil (separately)
clearly labeling the axes. (Note: The labor requirements per unit of output remain constant
irrespective of the quantity produced.)
b. What is the opportunity cost of producing an extra gallon of coffee in Argentina? In Brazil?
c. What is the opportunity cost of producing an extra yard of leather in Argentina? In Brazil?
d. Suppose that both Argentina and Brazil are self sufficient i.e., they each rely on their own
production for their consumption and do not trade with each other. Also assume that each nation
devotes exactly a half of its total labor availability to the production of coffee and the rest to the
production of leather. Indicate the combination of coffee and leather produced and consumed in
each country on the graphs of part (a).
e. Suppose each country devotes all its labor availability to the production of the commodity in
which it has a comparative advantage (i.e., a relatively lower opportunity cost). Indicate the
production point of each country after specialization. Again use graphs for part (a).
f. Show that the two countries could now exchange coffee for leather so that the consumption point
of both countries (after specialization and exchange) lies outside of their own PPFs. Give a
specific example.
g. Suppose we add Uruguay to the picture with 60 hours of labor and with an input requirement of
5 hours of labor for each unit of coffee and 5 hours of labor for each unit of leather. How would
this alter the joint PPF assuming we look at all three countries?
h. Assuming a market with only these three countries as suppliers of coffee, construct the coffee
supply curve based on the principle of comparative advantage.
2. Consider the following two equations that describe market activities in the Cortland NY tire market.
Let X = number of tires per month and P = price per tire
Equation A: X=500-2P
Equation B: X=-25+P
a. Which equation would represent the demand curve and why?
b. Which equation would represent the supply curve and why?
c. Find the market equilibrium price and number of tires traded, i.e., P* and X*.
d. Graph the equilibrium and label your graph carefully.
e. Suppose there was a quota placed on this market. What set of values for the quota would make
the quota binding?
f. Suppose the quota is set at Xquota= 75. Carefully and completely describe the consequence of
this quota on both demanders and suppliers. Show its effect in your diagram.
g. Suppose Ima Smart insists that a better policy is to impose a price floor that is set equal to the
market price you would get with the quota. Analyze Ima's suggestion using your graph and the
demand and supply equations.
h. Suppose that INSTEAD OF THE QUOTA the mayor of Cortland decides to place a per unit tax
of $5.00 per tire on each tire sold. The mayor decides to collect the tax revenue from the
suppliers of tires. Determine the new market situation and figure out how much demanders now
pay and how much suppliers now receive per tire after all is said and done (that is after all tire
taxes are paid). What side of the market would you say seems to have “eaten” relatively more of
the tax and why?
3. Consider a particular service - your choice. Listed below are some events that could have some
effect on one or more of the following with respect to that service: quantity demanded, quantity
supplied, demand, and supply. Indicate which of the above four are directly affected and in what
direction (i.e., increase, decrease, etc.).
a. The service becomes more fashionable.
b. An income tax is levied on consumers.
c. There is a rise in the price of an essential input used in production of the service.
d. The price of the service itself changes.
e. The price of a close substitute (substitute in consumption) increases.
4. Before market reforms were initiated in the Soviet Union back in 1991, prices were often set by the
government.
a. Explain, with the aid of a graph, why there were lines for ordinary consumer goods, such as
soap.
b. In October, 1990, the Soviet government announced that soap prices would double as of January
1, 1991. In the days just following the announcement soap lines increased. Explain how this
could have happened.
5. Suppose the supply function of apples in Upstate New York is: XS = 20 + 2PX – 3Y + 4Z where X
refers to apples. If the supply for apples also depends on fertilizer, which variable to do you think is
the price of fertilizer, Y or Z? Why do you think so?
6. Suppose that the demand for pork is QD = 286 – 20P where P is the price of pork. Suppose that the
supply for pork is: QS = 178 + 40P – 60Ph where P is the price of pork and Ph is the price of hogs.
Mathematically, how does the equilibrium price of pork vary as the price of hogs changes if the
variables that affect pork demand are held constant at their “ceteris paribus” values?
7. Use a demand and supply diagram to explain the statement, “Talk is cheap because supply exceeds
demand.” At what price is this comparison being made?
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