Economics 101
Spring 2002
Section 5-Alley
Problem Set #1
Answer Key (Answers in Bold)
1.
Give two examples of each of the following types of inputs for a producer who makes desks, chairs,
and file cabinets for home office use.
a.
b.
c.
2.
3.
Capital: saws, factory building, plastic molding equipment, sheet metal bending machines
Expendable: wood, steel, screws, plastic
Capital service: cutting done by saws, bending done by sheet metal bending equipment
Consider the following decision situations. In each, identify the opportunity cost of each of the
alternative choices.
a.
A lawyer who is deciding whether to take a case defending an indigent terrorist who will pay
nothing but will bring a lot of publicity to the lawyer’s firm, or to take a rather routine but
expensive divorce case that promises a huge fee but little publicity for the firm.
Take terrorist case: Large fee brought in on divorce case.
Take the divorce case: Publicity brought about by defending a high-profile defendant.
b.
A business man who has an illegal moonshine business who is deciding whether to operate his
business for another year with expected net returns of $70,000 or lease the business to his nephew
for $40,000 a year and work as a black jack dealer for $20,000 per year.
Continue makin’ ‘shine: $40,000 brought in by the lease, $20,000 income as black jack
dealer, the love of his nephew.
Go straight: $70,000 in income, the satisfaction of being an independent bussinessman
c.
A student who is considering a full time job for the coming year at $19,000 and cutting back on
his hours of credit from 16 per semester to 10 per semester. An alternative part time job
compatible with 16 credit hours pays $7,000 per year.
Full time job: the loss of credits, $7000 in income, there is an inherent opportunity cost in
taking longer to finish school as well
Part time job: $19,000 in oncome
Robinson Crusoe and Man Friday live on an island. The following table represents their output in a
day of work.
Fish
Cassava
Robinson Crusoe
5
20
Man Friday
8
24
a.
b.
c.
d.
Who has an absolute advantage in the production of fish?
Friday has an absolute advantage in fish (he can produce more in a day).
Who has an absolute advantage in the production of cassava?
Friday for the same reason as in a.
Who has a comparative advantage in digging cassava?
Robinson, he has a lower opp cost of producing cassava (see table below).
Who has a comparative advantage in fishing?
Man Friday, he has a lower opp cost of producing fish.
Make an Opportunity Cost Table:
Robinson
Man
Fish
4 Cassava
3 Cassava
Cassava
¼ Fish
1/3 Fish
4.
Consider the following data.
Tennis Shoes
43
42
40
36
30
22
12
0
Basketball Shoes
0
7
13
18
22
25
27
28
a.
What is the opportunity cost of 6 more tennis shoes when the firm is already producing 30?
22 – 18 = 4 b-ball shoes
b. What is the opportunity cost of 2 more tennis shoes when the firm is already producing 40?
13 - 7 = 6 b-ball shoes
c. What is the opportunity cost of 8 more tennis shoes when the firm is already producing 22?
25 – 22 = 3 b-ball shoes
d. What is happening to the opportunity cost of tennis shoes as the quantity produced goes up?
It is increasing .
The PPF graph below should be used for 6, 7, and 8.
6.
7.
Which point is not feasible?
B is not feasible. The ppf represents the maximum possible output.
When the firm is producing between 2 and 4 shirts, what is the opportunity cost of one more blouse?
Change in shirts over this part of the ppf = 4 – 2 = 2
Change in blouses over this part of the ppf = 22 – 14 = 8
Trade-off over this part of the ppf : 2 shirts = 8 blouses
 divide both sides by 8
 1 blouse = ¼ shirt
When the firm is producing between 0 and 14 blouses, what is the opportunity cost of one more
blouse? Using the same method as number 6: 1 blouse = 1/8 shirts
Production Possibility Set
Blouses
5.
26
24
22
20
18
16
14
12
10
8
6
4
2
0
A
B
E
D
C
0
0.5
1
1.5
2
2.5
3
3.5
Shirts
4
4.5
5
5.5
6
6.5
8.
Draw a production possibility frontier (boundary of P(x)) and give an example of a pair of goods for
a.
b.
the case where there is increasing opportunity cost.
The ppf in number 7 shows increasing opportunity cost. You know this because the slope of
the ppf represents the opportunity cost. As we move from the left end of the ppf to the right
end of the ppf, the slope is increasing (becoming more and more negative).
the case where there is constant opportunity cost.
Constant Opp Cost PPF
25
Butter
20
15
10
5
0
0
5
10
15
guns
9.
Consider the market for personal desktop computers. In a supply and demand diagram show a demand
curve and a supply curve. Label them D1 and S1 respectively. For each of the following situations
show the appropriate change in the curves, and indicate what will happen to the equilibrium price.
(Draw a separate graph for each situation.) See graphs on attached sheet.
a.
b.
c.
d.
e.
The government announces that having a computer at home increases a student’s GPA by
0.75 points. This changes peoples taste for computers. They want more. This shifts
demand out.
The economy goes into a recession and the income of most individuals falls. When
people have less money, they demand less at every price. This shifts demand to the
left.
Dell finds a way to make PC’s at half the cost. This is the case where technology
makes the production process more efficient. This shift supply to the right.
Intel increases the price at which they sell processor chips to computer manufactures by
50%. This is the case of an input becoming more expensive. This shifts supply to
the left.
Sony introduces a laptop that weighs ½ pound and has all of the features of the current
desktop computers at half the price of a desktop computer. This is the case where a
substitute becomes less expensive. This shifts the demand curve to the left.
10. For each of the following supply and demand curves, find the equilibrium price and quantity.
a. D = 20 – 2P
S = 2P – 8
Set D = S and solve for P
D = 20 – 2P = 2P – 8 = S
20 – 2P = 2P – 8
4P = 28
P=7
Plug the price into the supply or demand function to get quantity (I will use
demand):
D = 20 – 2(7) = 6 = Q
b. D = 40 – 2P
P = 12, Q = 16
c. D = 40 – P
P = 16, Q = 24
d. D = 20 – 2P
P = 6, Q = 8
e. D = 40 – 2P
P = 11, Q = 18
S = 2P – 8
S = 2P – 8
S = 2P – 4
S = 2P – 4
11. In a supply and demand diagram, show what will happen if the government imposes a binding price
ceiling on all carbonated beverages that come in cans.
P
S
PC
D
Q
QD
Qs
At the price ceiling, quantity demanded is greater that quantity supplied, so there is excess
demand. At this price, not all demand will be satisfied. The amount traded will be limited to
the quantity supplied at that price.
Consider the following diagrams for questions 12-13. In all cases the initial situation is at S0 and D0.
P
B
A
P
S1
S0
S0
P0
D1
Q0
D0
D0
Q
12. Consider panel A. This represents
a. a decrease in demand and a decrease in supply.
b. a decrease in price and an increase in supply.
c. a decrease in demand and a decrease in the quantity supplied.
d. a decrease in supply.
e. a decrease in the quantity demanded and a decrease in supply.
D1
Q
13. Consider panel B. This represents
a. an increase in demand and a decrease in the quantity supplied.
b. a decrease in the quantity supplied and an increase in price.
c. an increase in the quantity demanded and a decrease in supply.
d. a decrease in supply and an increase in demand.
e. a and d.
Number 9 Graphs
A
B
P
P
S0
S0
D0
D1
D1
D0
Q
Q
C
D
P
P
S0
S1
S1
D0
D0
Q
E
P
S0
D1
S0
D0
Q
Q