ECON 2105H
Macroeconomics (Honors)
Problem set 1 – Answers
Dr. Lastrapes
Fall 2000
1. An economist would not generally use this argument. Whereas the politician
considers only the expected benefits, he ignores the costs. An economist would (in
principle) consider all the opportunity costs of reducing the speed limit (e.g. value of
time given up by motorists driving more slowly, the value of resources used to
enforce tighter restrictions, etc.) If “only one” highway death is prevented, surely the
costs would exceed the benefits; there would presumably be lower costs alternatives
to achieving the objective of reducing highway deaths.
The optimal number of highway deaths is likely not zero, since the opportunity costs
of achieving such an extreme goal would probably be too high. After all, highway
deaths could be reduced to zero by eliminating highways (and thus cars). While the
costs of highway deaths are obvious, we shouldn’t forget about the costs of not
having highway deaths. In general, we can think of the optimal number of deaths as
the number that equates the (expected) marginal cost with the (expected) marginal
benefits of reducing deaths.
2. The cost of studying is the value of the movie ($20). The cost of the movie is $7 (the
value all the other goods you could have bought instead of the ticket) plus the value
you attach to studying for two hours ($12). The cost of going to the movie ($19) is
lower than the cost of studying, so you would go to the movie.
3. The point (3000,3000) must be inefficient in production. Note that this point lies on a
line connecting the efficient points (4000, 2000) and (2000, 4000). If marginal costs
are increasing, the production possibility frontier must be concave between these
efficient points; these points must necessarily be above the line connecting these
points.
4. PPF
a) Point A lies on the frontier
b) Assume that butter is measured on the horizontal axis while guns are measured on
the vertical. Then point B (cost of butter is lower) lies higher and to the left on the
same PPF as point C (cost of butter is higher).
c) Point D lies inside the frontier (if those resources would specialize, more of all
goods could be produced).
d) Point E lies outside the frontier (can be attained only if more resources or better
technology cause the frontier to shift to the right.
5. Indifference curve
a) Points A and B lie on the indifference curve
b) Suppose cigarettes are measured on the horizontal axis. Then point C lies higher
and to the left on the same indifference curve as point D.
c) Point E lies on a separate indifference curve than is to the right (northeast) of
point F’s indifference curve
6. Comparative advantage, specialization and trade
a) No, marginal costs are constant in this example (unrealistic, but simple).
b) In the U.S., producing 100 extra cars requires giving up 200 tons of wheat. The
cost of one extra car (the marginal car) is thus 2 tons of wheat. In Japan,
producing 200 extra cars requires giving up 100 tons of wheat. The cost of one
extra car is thus ½ ton of wheat.
c) The US has an absolute advantage in producing wheat, since it can produce more
wheat than Japan if only wheat is produced. Japan has an absolute advantage in
producing cars (in this problem). Japan has a comparative advantage in cars, since
it can produce cars at a lower marginal cost than the U.S.; the US has a
comparative advantage in wheat. (The fact that each country has a comparative
advantage and an absolute advantage in the same good is only coincidental.)
d) Suppose the US economy produces 1000 tons of wheat (and no cars), while the
Japanese economy produces 800 cars (and no wheat). Suppose also that car
buyers in the US and wheat buyers in Japan agree to a “price” of cars of 1 ton per
car. Then the US could trade 200 tons of wheat for 200 cars, so that consumers in
the US consume 800 tons of wheat and 200 cars. The Japanese receive 200 tons of
wheat by trading 200 cars; they thus consume 200 tons of wheat and 600 cars.
Both are better off by trading as compared to not trading (for example, without
trade, Japan could consume 200 tons of wheat only if it were willing to consume
400 cars).
e) If the world economy (the US and Japan) produces just wheat, it can produce
1400 tons (1000 from the US and 400 from Japan). Likewise, it could produce
1300 cars. Therefore, if wheat is on the vertical axis and cars on the horizontal,
the vertical intercept is 1400 and the horizontal intercept is 1300. Now, assume
the world initially produces just wheat (that is, begin at the vertical intercept).
Since Japan produces cars at the lower cost, the Japanese should produce cars
first. Thus, the aggregate PPF will have a slope of ½ from the vertical intercept to
the point (800 cars, 1000 wheat). From that point to the horizontal intercept, as
the US begins producing cars, the slope will be 2. The world PPF will roughly
have a concave shape. Production would be inefficient if the US producers cars on
the margin from the vertical intercept.