Lecture 1: The Science of Macroeconomics.

Ten Principles of Economics, Supply and

Demand.
Book 3:
Questions for Review:
1. Explain the difference between macroeconomics and microeconomics. How are these
two fields related?
Macroeconomics is the study of the economy as a whole. While microeconomics is the study of
how individual households and how firms make decisions and how they interact with one
another in markets. These two fields are related through the fact that they both depend on each
other.
2. Why do economists build models?
Economists build models to explain or make predictions about economic issues and problems.
3. What is a market-clearing model? When is it appropriate to assume that markets clear?
Market-clearing models are economic models grounded in the law of supply and demand. In
which demand and supply are in equilibrium.
Problems and Applications:
1. List three macroeconomic issues that have been in the news lately.
Unemployment, inflation, and economic growth.
2. What do you think are the defining characteristics of a science? Do you think
macroeconomics should be called a science? Why or why not?
I think that the defining characteristics of science are observability, predictability, testability, and
consistency. I think that macroeconomics can be called a science because it deals with the
science of society and how we survive.
3. Use the model of supply and demand to explain how a fall in the price of frozen yogurt
would affect the price of ice cream and the quantity of ice cream sold. In your
explanation, identify the exogenous and endogenous variables.
Since yogurt is a substitute good for ice cream and the price of the substitute good is falling, the
demand curve for ice cream would shift to the left. This price fall in frozen yogurt also causes an
increase in demand for it as by nature it is quite similar and may satisfy the needs. The price of
forzen yogurt is the exogenous variable and the endogenous is the price of ice cream, and the
supply of ice cream sold.
4. How often does the price you pay for a haircut change? What does your answer imply
about the usefulness of market-clearing models for analyzing the market for haircuts?
The price of haircuts changes infrequently. Hairstylist change the prices over a 1 or 2 year
period. A markeet-clearing model for analyzing the market for haircuts has the unrealistic
assumption of flexible prices. Over the long run, the price of haircuts does tend to adjust.
Therefore a market-clearing model is appropriate.
Book 2:
Questions for Review:
1. Give three examples of important trade-offs that you face in your life.
Job vs Family, Savings vs Expenses, and Income vs Leisure.
2. What items would you include to figure out the opportunity cost of a vacation to
Disneyworld?
To figure out the opportunity cost of a trip to Disney Worls, you would need to include the
monetary costs of admission, travel, and shopping. You would also include the cost of time spent
on vacation.
3. Water is necessary for life. Is the marginal benefit of a glass of water large or small?
The marginal benefit of a glass of water depends on your circumstances. For example, if you run
a marathon or you have been walking in the desert sun for three hours, the marginal benefit is
very high. But if you have been drinking a lot of liquids recently, the marginal benefit is low.
4. Why should policymakers think about incentives?
Policymakers need to think about incentives so they can understand how people will respond to
the polices they put in place.
5. Why isn’t trade among countries like a game with some winners and some losers?
Trade between two countries is not a game where one loses, and one wins because trade can
make both better off. By allowing specialization, trade between people and trade between
countries can improve everyone’s welfare.
6. What does the “invisible hand” of the market failure and give an example of each.
The “invisible hand” of the marketplace represents the idea that even though individuals and
firms are all acting like their own self-interest, prices and the marketplace guide them to do what
is good for society as a whole.
7. Explain the two main causes of market failure and give an example of each.
The two main causes of market failure are externalities and market power. An externality is the
effect of one person’s actions on the well-being of a bystander, such as from pollution or the
creation of knowledge. Market power refers to the ability of a single person (or small group of
people) to unduly influence market prices, such as in a town with only one well or only one cable
television company.
8. Why is productivity important?
Productivity is important because a country’s standard of living depends on its ability to produce
goods and services.
 9. What is inflation and what causes it?
Inflation is an increase in the overall level of prices in the economy. Inflation is caused by the
increase in the quantity of a nation’s money.
10. How are inflation and unemployment related in the short run?
Inflation and unemployment are negatively related in the short run. Reducing inflation entails
costs to society in the form of higher unemployment in the short run.
Quick Check Multiple Choice:
1. Economics is best defined as the study of...
a) How society manages its scarce resources
b) How to run a business most profitably
c) How to predict inflation, unemployment, and stock prices
d) How the government can stop the harm from unchecked self-interest
2. Your opportunity cost of going to a movie is
a) The price of the ticket
b) The price of the ticket plus the cost of any soda and popcorn you buy at the theater
c) The total cash expenditure needed to go to the movie plus the value of your time
d) Zero, as long as you enjoy the movie and consider it a worthwhile use of time and money

3. A marginal change is on that

a) Is not important for public policy
b) Incrementally alters an existing plan
c) Makes and outcome inefficient
d) Does not influence incentives
4. Adam Smith’s “invisible hand” refers to
a) The subtle and often hidden methods that businesses use to profit at consumer’s expense
b) The ability of free markets to reach desirable outcomes, despite the self-interest of market
participants
c) The ability of government regulation to benefit consumers, even if the consumers are
unaware of the regulations
d) The way in which producers or consumers in unregulated markets impose costs on
innocent bystanders
5. Governments may intervene in a market economy in order to
a) Protect property rights
b) Correct a market failure due to externalities
c) Achieve a more equal distribution of income
d) All of the above
6. If a nation has high and persistent inflation, the most likely explanation is
a) The central bank creating excessive amounts of money
b) Union's bargaining for excessively high wages
c) The government imposing excessive levels of taxation
d) Firms using their monopoly power to enforce excessive price hikes
Problems and Applications:
1. Describe some of the trade-offs faced by each of the following:
a) A family deciding whether to buy a new car
The cost of the car vs the convenience and reliability of having a new vehicle, the cost of car
payments, vs the ability to save money for other expenses, the cost of insurance maintenance for
a new car vs the cost of keeping an old car.
b) A member of congress deciding how much to spend on national parks.
Between the budgetary allocation of the government to national parks and spending on other
resources.
c) A company president deciding whether to open a new factory.
Between the cost of opening a new factory and the cost of allocation it for some other purpose.
d) A professor deciding how much to prepare for class.
Between the spending of time for preparation and using it for personal use.
e) A recent college graduate deciding whether to go to graduate school.
Between the decision of whether to go for a job or to study.
2. You are trying to decide whether to take a vacation. Most of the costs of the vacation are
measured in dollars, but the benefits of the vaction are psychological. How can you
compare the benefits to the cost.
The cost and benefit will vary between individuals, and everyone has many different motives for
taking a vaction. If a person thinks that they need some psychological relaxation, and they can
get it from a vacation, it cannot be considered a cost, it would be a benefit. At the same time, if
they do not get any psychological benefits, it would be a cost.
3. You were planning to spend Saturday working at your part-time job, but a friend asks you
to go skiing. What is the true cost of going skiing? Now suppose you had been planning
to spend the day studying at the library. What is the cost of going skiing in this case?
Explain.
The cost of going skiing in the first instance would be that since you are not working you would
not be getting paid. And if you need the money for bills and other expenses it would be a good
idea not to go skiing. Now in the second instance your education may be a cost. If you spend the
day studying at the library there is a higher chance that you would pass the class and/or exam. If
you went skiing that chance decreases immensly.
4. You win 100$ in a basketball pool. You have a choice between spending the money now
and putting it aways for a year in a bank account that oays 5 percent intrest. What is the
opportunity cost of spending the 100$ now?
The intrest amount will be 5$ if deposited into the bank. The opportunity cost will also be 5$,
which cannot be earned if the money is spent now.
 5. The company that you manage has invested $5 million in devolping a new product, but
the decelopment is not quite finished. At a recent meeting, your sales people report that
the introduction of competing products has reduced the expected sales of your new
product to $3 million. If it woulf cost $1 million to dinish development and make the
product, should you go ahead and do so? What is the most that you should pay to
complete development?
The total cost involved in the project would be $6 million. The most that can be paid for the
projects development will be no more that $3 million. In the case, no one should go ahead with
the project.
6. The Soccial Security system provided income for people over age 65. If a recipient of
Social Security decides to work and earn some income, the amoung received in Social
Security benefits is tupplically reduced.
a) How does the provision of Social Security affect people’s incentive to save while
working?
Since working while getting social secutiry leades to reduction of benefits, a typical person will
benefit from not working and will be incentivized to not work, and no one wants to lose on
benefits even after working, and everyone loves freee benefits. If the person works, his saving
level increases.
b) How does the reduction in benefits associated with higher earnings affect people’s
incentive to work past age 65?
Since a person gets fewer after-tax Social Security benefits the greater their earnings are, this
lowers the incentive not to work after age 65. The more work, the lower your after-tax Social
Security benefits will be. Making the taxation of Social Security benefits discourages work effort
after age 65.
7. A 1996 bill reforming the federal governments anti-porvery programs limited many
welfare recipients to only two years of benefits.
a) How does this change affect the incentives for working?
This change gives people the incentive to find a job more quickly than if welfare benefits lasted
forever.
b) How might this change represent a trade-off between equality and efficiency?
This change in the government's antipoverty program reduces equality in the distribution of
income, since those who cannot find a job will get no income at all. However, the economy is
more efficient given the increased incentive for the unemployed to find work and contribute to
the nation's output.
8. Explain whether each of the following government activites is motivated by a concern
about equality or a concern about efficiency. IN the case of efficiency, discuss the type of
market failure involved.
a) Regulating cable TV prices.
This shows the government's concern about efficiency. The market failure involved is due to
market power where small groups of people or a single person influences market prices.
b) Providing some poor people with vouchers that can be used to buy food.
This shows the governments concern about equality
c) Prohibiting smoking in public places.
This shows the government's concern about efficiency. The market failure involved is known as
an externality. It shows the negative impact of the smoker's action on the well-being of others.
d) Breaking up Standard Oil into several smaller companies.
This shows the government's concern about efficiency. The market failure involved is due to
market power, where Standard Oil would unduly influence the market prices of oil and exploit
people.
e) Imposing higher personal income tax rates on people with higher incomes.
This shows the governments concern about equality.
f) Instituting laws against driving while intoxicated.
This shows the government's concern about efficiency. The market failure involved is known as
an externality. It shows the negative impact of the intoxicated driver’s action on the well-being
of others.
9. Discuss each of the following statements from standpoints of equality and efficiency.
A) “everyone in society should be guaranteed the best healthcare possible”
Providing the best healthcare possible to everyone is an equality concern. Doing so would
reduce our nation's efficiency since the costs of providing the best healthcare for all would be
very high. It would be more efficient to provide those who do not get healthcare through their
employer with quality healthcare or at least provide a discount.
b) “When workers are laid off, they should be able to collect unemployment benefits until they
find a new job”
Providing unemployment benefits until a person finds a job is an equality concern. However, it
would hurt our economy since some may receive it for months or even years. A more efficient
approach would be to provide it for a set period and to verify that the recipient is actively seeking
employment
10. In what ways is your standard of living different from that of your parents or
grandparents when they were your age? Why have these changes occurred?
The standard of living could be defined as the degree of comfort and luxury a persosn enjoys due
to increased income or wealth.
11. Suppose Americans decide to save more of their incomes. If banks lend this extra saving
to businesses, which use the funds to build new factories, how might this lead to faster
 growth in productivity? Who do you suppose benefits from the higher productivity? Is
society getting a free lunch?
The income and the growth and productivity of the country are interrelated and dependent on one
another. The rising income will lead to an increase in the country’s growth, and the rise in the
productivity of the country will result in a rise in its income. Society is not getting a free lunch.
12. During the Revolutionary War, the American colonies could not raise enough tax revenue
to fully fund the war effort; to make up the difference, the colonies decided to print more
money. Printing money to cover expenditure is sometime referred to as an “inflation tax.”
Who do you think is being “taxed” when more money is printed? Why?
When more money is printed, the value of existing money decreases and as a result, prices of
goods and services increase. This causes people to pay more for the same amount of goods and
services they were buying before, effectively increasing their expenses. Therefore, the general
public is being “taxed” as they have to spend more money to maintain their standard of living.
This is known as inflation, and it results in a redistribution of wealth from the general public to
the government. The government benefits as it can now finance its expenses with the newly
printed money, while the general public is left paying more for the dame goods and services.
Lecture 2: Measuring a National Income
Questions for Review:
1. How is economics a science?
Economics is a science because they devise theories, collect data, and then analyze this data in an
attempt to verify or refute their theories.
2. Why do economists make assumptions?
Economists make assumptions because it is a better understanding a consumer and business
behavior when making economic decisions.
3. Should an economic model describe reality exactly?
No, economics can be a perfect description of reality.
4. Name a way that your family interacts in the factor market and a way that it interacts in
the product market.
A way that my family interacts in the factor market is that my family is the “buyer” of the
product, and the firms are the “sellers.”
5. Name one economic interaction that isn't covered by the simplified circular-flow
diagram.
One economic interaction that is not covered by the simplified circular-flow is taxation.
6. Draw and explain a production possibilities frontier for an economy that produces milk
and cookies. What happened to this frontier if disease kills half of the economy’s cows?
If the disease kills half of the economy’s cows then the economy will have a big struggle on
producin and selling milk. Milk would be limited and sell quicker because everyone would want
to get milk when they have the chance to.
7. Use a production possibilities frontier to describe the idea of “efficiency.”
A production is water because everyone needs water in order to survive and if water was limited
then there woulf be a big stuggle with finding or getting water. Everyone would go crazy if water
was selling so quickly and some may not get any at all.
8. What are the two subfeild into which economics is divided? Explain what each subfield
studies.
The field of economics is traditionally divided into two broad subfields. Mircoeconomics is the
study of how households and firms make decisions and how they interact in specific markets.
Macroeconomics os the study of economy wide phenomena.
9. What I the difference between a postive and a normative statement? Give an example of
each.
The difference between positve and normative statements is how we judge their validity. An
example of a positve statement is examining evidence and a normative statement involves
judgment.
10. Why do economists sometimes offer confliction advice to policymakers?
Economists sometimes offer conflicting advice to policy makers because economists may
disagree about the validity of alternative positive theories about how the world works.
Mutiple Choice:
1. An economis model is:
a) A mechanical machine that replicates the functioning of the economy.
b) A fully detailed, realistic description of the economy.
c) A simplified representation of some aspect of the economy
d) A computer programe that predicts the future of the economy
2. The circular-flow diagram illurtrates that, in markets for the factor of prodcution,
a) Households are sellers, and firms are buyers
b) Households are buyers, and firms are sellers
c) Households and firms are both buyers
d) Households and firms are both sellers
3. A point inside the production possiblities frontier is:
a) Efficient, but not feasible
b) Feasible but not efficient
c) Both efficient and feasible
d) Neither efficient or feasible
4. An economy produces hot dogs and hamburgers. If a discovery of the remarkable health
benefits of hot dogs were to change consumers preferences, it would:
a) Expand the production possibilites frontier
 b) Contract the production possibilities frontier
c) Move the economy along the production possibilities frontier
d) More the economy inside the production possibilities frontier
5. All of the following topics fall within the study of microeconomics EXCEPT:
a) The impact of cigaretter taxes on the smoking behavior of teenagers
b) The rold of Microsofts market power in the pricing of software
c) The effectiveness of antipoverty programs in reducing homelessness
d) The influence of the governmetn budget deficit on economic growth
6. Which of the following is a positive, rather thans a normative, statement?
a) Law X will reduce national income
b) Law X is a good piece of legislation
c) Congress ought to pass Law X
d) The president shoulde veto Law X
Problems and Applications
4. Draw a circular-flow diagram. Identify the parts of the model that correspond to the flow
of goods and services and the flow of dollars for each of the following activities.
e) Selena pays a storekeeper $1 for a quart of milk.
Flow of goods and services: Quart of milk from the store to Selena. Flow of dollars: $1 from
Selena to the storekeeper.
f) Stuart earns $4.50 per hour working at a fast-food restaurant.
Flow of goods and services: Stuart's labor (fast-food service). Flow of dollars: $4.50 from the
fast-food restaurant
g) Shanna spends $30 to get a haircut.
Flow of goods and services: Haircut service from the barber to Shanna. Flow of dollars: $30
from Shanna to the barber.
h) Salma earns $10,000 from her 10 percent ownership of Acme Industrial.
Flow of goods and services: Not applicable (ownership does not involve the exchange of goods).
Flow of dollars: $10,000 in dividends from Acme Industrial to Salma.
2. Imagine a society that produces military goods and consumer goods, which we'll call "guns"
and "butter."
i) Draw, a production possibilities frontier for guns and butter. Using the concept of
opportunity cost. explain why it most likely has a bowed-out shape.
As an economy reallocates resources from producing one good to the other, the opportunity cost
increases because resources are better suited for the initial production.
j) Show a point that is impossible for the economy to achieve. Show a point that is feasible
but inefficient.
Impossible Point: Any point outside the PPF (beyond its limits) is impossible to achieve.
Inefficient Point: A point inside the PPF represents inefficient resource allocation, indicating that
more of both goods can be produced without sacrificing either.
k) Imagine that the society has two political parties, called the Hawks (who want a strong
military) and the Doves (who want a smaller military). Show a point on your production
possibilities frontier that the Hawks might choose and a point that the Doves might
choose.
Hawks might choose a point favoring more guns (strong military), while Doves might choose a
point favoring more butter (smaller military).
l) Imagine that an aggressive neighboring country reduces the size of its military. As a
result, both the Hawks and the Doves reduce their desired production of guns by the same
amount. Which party would get the bigger "peace dividend," measured by the increase in
butter production? Explain.
If both of the Hawks and Doves reduce desired gun production, the peace dividend (increase in
butter production) would likely be similar for both parties since they jointly agree to reduce
military production.
3. The first principle of economics discussed in Chapter 1is that people face trade-offs. Use a
production possibilities frontier to illustrate society's trade-off between two "goods" - a clean
environment and the quantity off industrial output. What do you suppose determines the shape
and position of the frontier? Show what happens to the frontier if engineers develop a new way
of producing electricity that emits fewer pollutants.
The PPF's position and shape are influenced by things like resource availability, technological
advancements, and the harmony between industrial output and environmental protection. The
PPF will shift outward if engineers create a new, more environmentally friendly method of
generating electricity, enabling increased industrial productivity without compromising
environmental quality.
4. An economy consists of three workers: Larry, Moe, and Curly. Each works 10 hours a day and
can produce two services: mowing lawns and washing cars. In an hour, Larry can either mow
one lawn or wash one car; Moe can either mow one lawn or wash two cars; and Curly can either
mow two lawns or wash one car.
m) Calculate how much of each service is produced under the following circumstances,
which we labeled ABC and D
4, B, C, and D-sAl three spend all their time mowing lawns. (A) Larry: 10 lawns, Moe: 10
lawns, Curly: 10 lawns.
*All three spend all their time washing cars. (B) Larry: 20 cars, Moe: 20 cars, Curly: 10 cars.
•All three spend half their time on each activity. (C) Larry: 5 lawns, 10 cars; Moe: 5 lawns, 10
cars; Curly: 5 lawns, 10 cars.
•Larry spends half his time on each activity, while Moe only washes cars and Curly only mows
lawns. (D) Larry: 5 lawns, 5 cars; Moe: 0 lawns, 10 cars; Curly: 10 lawns, 0 cars.
n) Graph the production possibilities frontier for this economy. Using your answers to part
(a), identify points A, B, C, and D on your graph.
o) Explain why the production possibilities frontier has the shape it does.
The PPF has a bowed-out shape because resources are not equally efficient in producing both
goods. As an economy shifts resources from one activity to another, the opportunity cost
increases because the resources are less suitable for the second activity.
p) Are any of the allocations calculated in part(a)inefficient? Explain.
Yes because the allocations calculated in parts A, B, and D are inefficient because they are inside
the PPF. These points represent underutilization of resources, and more of at least one good
could be produced without sacrificing the other.
5. Classify the following topics as relating to microeconomics or macroeconomics.
q) family's decision about how much income to save.
Microeconomics.
 r) the effect of government regulations on auto emissions
Microeconomics.
s) the impact of higher national saving on economic growth
Macroeconomics
t) A firm's decision about how many workers to hire
Microeconomics
u) the relationship between the inflation rate and changes in the quantity of money
Macroeconomics
6. Classify each of the following statements as positive or normative. Explain.
v) Society, faces a short-run trade-off between inflation and unemployment.
Positive. Factual statement
w) A, reduction in the rate of money growth will reduce the rate of inflation.
Positive. Factual statement
x) The Federal Reserve should reduce the rate of money growth.
Normative. Is a recommendation
y) Society ought to require welfare recipients to look for jobs Normative. Is a judgement on
values.
z) Lower tax rates encourage more work and more saving
Positive. Realistic situation.

Lecture 3: Measuring the Cost of Living

Questions for Review:
5. Under what conditions is the production possibilities frontier linear rather than bowed
out.
When an economy can switch resources between two products without the opportunity costs
rising, this is known as a linear PPF. When both items have constant opportunity costs, which
means that the resources needed to manufacture one good may simply be employed to make the
other, this is how it usually works.
6. Explain how absolute advantage and comparative advantage differ.
Comparative advantage is used when describing the opportunity costs faced by two producers.
Absolute advantage is used when comparing the productivity of one person, firm, or nation to
that of another.
7. Give an example in which one person has an absolute advantage in doing something but
another person has a comparative advantage.
Ben and Alex mow lawns and wash cars. Alex has an absolute advantage in both activities
because he can perform both tasks faster. Ben has a comparative advantage in mowing lawns
because his opportunity cost of mowing is lower.
8. Is absolute advantage or comparative advantage more important for trade? Explain your
reasoning using the example in your answer to Question 3.
Comparative advantage is more important for trade because it focuses on the opportunity cost of
producing one good over another. Trade allows entities to specialize in producing the goods or
services where they have a comparative advantage, resulting in greater overall production
efficiency and mutually beneficial trade relationships.
 9. If two parties trade based on comparative advantage and both gain, in what range must
the price of the trade lie?
The trade price must be higher than the opportunity cost for the exporter and lower than the
opportunity cost for the importer to make the trade mutually beneficial.
10. Why do economists oppose policies that restrict trade among nations?
Economists generally oppose trade restrictions among nations because such restrictions, like
tariffs or import quotas, can lead to several negative economic consequences. They include
reduced efficiency, higher prices, and less economic growth.

Multiple Choice:
11. A change in which of the following will NOT shift the demand curve for hamburgers?
B. the price of the hamburgers
12. An increase in will cause a movement along a given demand curve, which is called a
change in .
B. supply, quantity demanded
13. Movie tickets and DVDs are substitutes. If the price of DVDs increases, what happens in
the market for movie tickets
B. The supply curve shifts to the right
14. The discovery of a large new reserve of crude oil will shift the curve for gasoline,
leading to a equilibrium price.
B. Supply, lower
15. If the economy goes into a recession and incomes fall what happens in the markets for
inferior goods?
B) Prices and quantities both rise
6. Which of the following might lead to an increase in the equilibrium price of jelly and a
decrease in the equilib-tivo quantity of jelly sold
C. an increase in the price of grapes, an input into jelly

Problems and Applications:

16. Maria can read 20 pages of economics in an hour. She can also read 50 pages of
sociology in an hour. She spends 5 hours per day studying.
aa) Draw, Maria's production possibilities frontier for reading economics and sociology.
bb) What is Maria's opportunity cost of reading 100 pages of sociology?
The opportunity cost of reading 100 pages of sociology is the number of economics pages she
could have read instead. Her opportunity cost is 4 pages of economics.
2. American and Japanese workers can each produce 4 cars a year. An American worker
can produce 10 tons of grain a year, whereas a Japanese worker can produce 5 tons of grain a
year.
To keep things simple, assume that each country has 100 million workers.
cc) In this situation, construct a table analogous to the table in Figure 1.
 Cars Grain (tons)

US 400M 1000M

Japan 400M 500M

dd) Graph the production possibilities frontiers for the American and Japanese economies.
ee) For the United States, what is the opportunity cost of a car? Of grain? For Japan, what is
the opportunity cost of a car? Of grain? Put this information in a table analogous to Table
1.
Opportunity Costs (per 100 million workers):
• U.S.: 1 car = 2.5 tons of grain Japan:
• 1 car = 10 tons of grain
ff) Which country has an absolute advantage in producing cars? In producing grain?
The countries have the same absolute advantage in producing cars. The US has the absolute
advantage in producing grain.
gg) Which country has a comparative advantage in producing cars? In producing grain?
• U.S.: Comparative advantage in producing grain (lower opportunity cost).
• Japan: Comparative advantage in producing cars (lower opportunity cost).
hh) Without trade, half of each country's workers produce cars and half produce grain. What
quantities of cars and grain does each country produce?
• U.S.: 200 million cars and 5000 million tons of grain
• Japan: 200 million cars and 1000 million tons of grain
ii) Starting from a position without trade, give an example in which trade makes each
country better off.
The US should trade grain because they have a lower opportunity cost, while Japan should trade
cars as they have a lower opportunity cost in that. Both countries would benefit from this trade.
3. Pat and Kris are roommates. They spend most of their time studying (of course), but they
leave sometime for their favorite activities: making pizza and brewing root beer. Pat takes 4
hours to brew a gallon of root beer and 2 hours to make a pizza. Kris takes 6 hours to brew a
gallon of root beer and 4 hours to make a pizza
jj) What is each roommate's opportunity cost of making a pizza? Who has the absolute
advantage in making pizza? Who has the comparative advantage in making pizza?
Pat has the opportunity cost of 2 hours of root beer production when making a pizza. Kris has the
opportunity cost of 4 hours of root beer brewing when making a pizza. Pat has the absolute
advantage. Pat also has the comparative advantage in making pizza.
kk) If Pat and Kris trade foods with each other, who will trade away pizza in exchange for
root beer?
Pat would trade pizza while Kris would trade root beer. This is because Pat has the comparative
advantage and Kris has a higher opportunity cost for making pizzas.
ll) The price of pizza can be expressed in terms of gallons of root beer. What is the highest
price at which pizza can be traded that would make both roommates better off? What is
the lowest price? Explain.
A gallon of root beer should be worth around three pizzas. One pizza is worth 1/3 gallon of root
beer. This is because three pizzas and a gallon of root beer both take around 6 hours to make.
4. Suppose that there are 10 million workers in Canada and that each of these workers can
produce either 2 cars or 30 bushels of wheat in a year.
mm) What is the opportunity cost of producing a car in Canada? What is the
opportunity cost of producing a bushel of wheat in Canada? Explain the relationship
between the opportunity costs of the two goods.
Opportunity cost of producing one car is half a year and about 150 million bushels of wheat. The
opportunity cost of producing a bushel of wheat is around 12 days, and around 670,000 cars.
Canada has a much larger opportunity cost when producing cars, meaning that they have a
comparative advantage when producing wheat.
nn) Draw Canada's production possibilities frontier. If Canada chooses to consume 10 million
cars, how much wheat can it consume without trade? Label this point on the production
possibilities frontier.
oo) Now suppose that the United States offers to buy 10 million cars from Canada in
exchange for 20 bushels of wheat per car. If Canada continues to consume 10 million
cars, how much wheat does this deal allow Canada to consume? Label this point on your
diagram. Should Canada accept the deal?
Canada is allowed to consume 200 million bushels of wheat, more than they normally would.
Canada's acceptance of the offer depends on the demand of the country. If Canada values cars
more than wheat, the deal should not be taken. But if Canada needs the extra wheat, the deal
should be accepted.
5. England and Scotland both produce scones and sweaters. Suppose that an English worker can
produce 50 scones per hour or I sweater per hour. Suppose that a Scottish worker can produce 40
scones per hour or 2 sweaters per hour.
pp) Which country has the absolute advantage in the production of each good? Which
country has the comparative advantage?
England has the absolute advantage in scones while Scotland has the absolute advantage in
sweaters. England has the comparative advantage in scones and Scotland has the comparative
advantage in sweaters.
qq) If England and Scotland decide to trade, which commodity will Scotland trade to
England? Explain.
Scotland will trade sweaters to England. They have the comparative and absolute advantage in
that item, making it beneficial for them.
rr) lf a Scottish worker could produce only 1 sweater per hour, would Scotland still gain
from trade? Would England still gain from trade? Explain.
Scotland and England would still gain from this trade because the opportunity cost of Scotland
making a sweater is still lower than England's. This means the comparative advantages are the
same.
6. The following table describes the production possibilities of two cities in the country of
Baseballia :Pairs of Red Socks per Worker per Hour: Boston:3 Chicago:2 Pairs of White Socks
per Worker per Hour: Boston:3 Chicago:1
ss) Without trade, what is the price of white socks(in terms of red socks) in Boston? What is
the price in Chicago?
In Boston, one white sock is worth one red sock. In Chicago, one white sock is worth % red
socks.
tt) Which city has an absolute advantage in the production of each color sock? Which city
has a comparative advantage in the production of each color sock?
Boston has the absolute advantage in white and red socks. Chicago has the comparative
advantage in red socks while Boston has the comparative advantage in white socks.
uu) lf the cities trade with each other, which color sock will each export?
Boston will export white socks and Chicago will sport red socks.
vv) What is the range of prices at which trade can octar?
The price of one pair of white socks should be 1 or 2 red socks.
7. A German worker takes 400 hours to produce a car and 2 hours to produce a case of wine. A
French worker takes 600 hours to produce a car and X hours to produce a case of wine.
ww) For what values of X will gains from trade be possible? Explain.
Any number that is not 3. This would give France a comparative advantage and make trade
beneficial.
xx) For what values of X will Germany export cars and import wine? Explain.
Germany will export cars and import wine for values less than 3. This is because this trade is
beneficial to both France and Germany.
8. Suppose that in a year an American worker can produce 100 shirts or 20 computers and a
Chinese worker can produce 100 shirts or 10 computers.
yy) For each country, graph the production possibilities frontier. Suppose that without trade
the workers in each country spend half their time producing each good. Identify this point
in your graphs.
zz) If these countries were open to trade, which country would export shirts? Give a specifie
numerical example and show it on your graphs. Which country would benefit from trade?
China would export shirts because they have the comparative advantage. They make 100 shirts
for every u computers while America makes 100 shirts for every 20 computers. Both countries
would benefit.
aaa) Explain, at what price of computers (in terms of shirts) the two countries might
trade.
China would trade I computer for 10 shirts. America would trade 1 computer for 5 shirts.
bbb) Suppose that China catches up with American productivity so that a Chinese
worker can produce 100 shirts or 20 computers. What pattern of trade would you predict
now? How does this advance in Chinese productivity affect the economic wellbeing of
the citizens of the two countries?
There would no longer exist the need for trade. Trade will only occur if certain demands are met.
Citizens of China and America will have similar well-beings.
9. Are the following statements true or false? Explain in each, case.
ccc) "Two countries can achieve gains from trade even if one of the countries has an absolute
advantage in the production of all goods."
True: Benefits from trade come from having a comparative advantage for a specific set of goods.
As long as a country has a comparative advantage for a good, both countries will benefit.
ddd) Certain, very talented people have a comparative advantage in everything they
do."
False: Comparative advantages are based on opportunity costs, not talent or skill. Some talented
people will have higher opportunity costs than others.
eee) If a certain trade is good for one person, it can't be good for the other one.
False: evervone has different demands and needs for different goods.
fff) lf a certain trade is good for one person, it is always good for the other one."
False: Not everyone has the same needs, and trade is not beneficial in some cases.
ggg) lf trade is good for a country, it must be good for everyone in the country."
While trade can bring overall economic benefits to a country by increasing efficiency the
benefits may not be equally distributed among all individuals