Assignment 1: Homework#1

Q1.

Fig. 1
(a) The graph (Fig. 1) illustrates a trade-off because all choices made on the PPF involve a trade-
off. So, to produce more gallons of Sunscreen, Wooyoung has to sacrifice in production of
pounds of food. For example: In moving from point A to B, in order to produce 50 more gallons of
Sunscreen, Wooyoung has to sacrifice the production of 100 pounds of Food. This proves that there
is a trade-off involved, since the resources are scarce (labour, land, capital, entrepreneurship)
and have alternative uses.

(b) Wooyoung’s opportunity cost of producing one pound of food is equals to:

To produce 100 pounds of food, Wooyoung has to sacrifice production of 50 gallons of sunscreen.
Thus, the opportunity cost to produce one pound of food is ½ gallons of sunscreen.

100 Pounds of Food = 50 gallons of Sunscreen

1 Pound of Food = ½ gallons of Sunscreen
(c) Wooyoung’s opportunity cost of producing one gallon of sunscreen is equals to:

To produce 50 gallons of sunscreen, Wooyoung has to sacrifice production of 100 pounds of food.
Thus, the opportunity cost to produce one gallon of sunscreen is 2 pounds of food.

50 gallons of Sunscreen = 100 pounds of Food

1 gallons of Sunscreen = 2 pounds of Food

(d) The relationship between part (b) and (c) is that there exists an inverse relationship between the
two opportunity costs. To produce one pound of food, the opportunity cost is ½ gallons of
sunscreen. Inversely, to produce one gallon of sunscreen, the opportunity cost is 2 pounds of food.
Thus, there exists an inverse relationship between part (b) and part (c), that is the opportunity
costs in both cases.

Q2.

Fig. 2 Fig. 3

(a) In producing pies, Lim has a comparative advantage over Kim, since the opportunity cost for
Lim to produce one pie is 2 cookies compared to Kim, who has a higher opportunity cost since for
Kim, the opportunity cost of producing 1 pie is 10 cookies.

Kim Lim
4O PIES = 400 COOKIES 100 PIES = 200 COOKIES
Opportunity cost: 1 PIE = 10 COOKIES Opportunity Cost: 1 PIE = 2 COOKIES
(b) Kim would be able to produce 20 pies and 200 cookies in one hour, whereas Lim would be able
to produce 50 pies and 100 cookies in one hour.

Kim Lim
In one hour, In one hour,
Kim can produce 40 Pies or 400 Cookies. Lim can produce 100 Pies or 200 Cookies.
Thus, in 30 mins, Thus, in 30 mins,
Kim can produce half of what he can produce in Lim can produce half of what he can produce in
one hour. That is, one hour. That is,
Kim can produce 20 Pies & 200 Cookies. Lim can produce 50 Pies & 100 Cookies.

(c) Lim has a comparative advantage in the production of pies, so Lim would be able to produce 100
pies in one hour. Kim has a comparative advantage in the production of cookies, so Kim would be
able to produce 400 cookies in one hour.

Kim Lim
Kim has a comparative advantage in the Lim has a comparative advantage in the
production of cookies and Kim can either production of pies and Lim can either produce
produce 400 cookies or 40 pies. 100 pies or 200 cookies.
Thus, in one hour, Thus, in one hour,
Kim will produce 400 cookies owing to his Lim will produce 100 pies owing to his
comparative advantage. comparative advantage.

(d) The highest price at which Kim and Lim would agree to trade a pie would be 9 cookies. They
would agree to the price of 1 pie = 9 cookies, since the trade ratio with which both Kim and Lim
would agree to trade would be 10C > 1P > 2C. According to the opportunity cost, if the price is
1 pie = 10 cookies, Kim would not agree to trade if the price is equal or more than 10 cookies, so
Kim would only agree to anything lower than 10 cookies. If the price is 1 pie = 2 cookies, Lim
would not agree to trade if the price is equal or less than 2 cookies , so Lim would only agree to
anything higher than 2 cookies.

(e) In Part (d), we established that the highest price at which Kim and Lim would agree to trade a pie
is 1 pie = 9 cookies. From the new trade, Kim would get to produce 20 pies and 220 cookies which is
20 cookies more compared to the amount of cookies Kim would produce in part (b), which was 20
pies and 200 cookies. Similarly, Lim would get to produce 80 pies and 180 cookies which is 30 more
pies and 80 more cookies compared to the amount Lim got in part (b), which was 50 pies and 100
cookies. Thus, both Kim and Lim would benefit from the grade and have gains from trade, as
both of them will start producing outside their original Production Possibility Frontier.

 For Kim, the tradeline is represented by Line AB. (Fig. 4)

 For Lim, the tradeline is represented by Line CD. (Fig. 5)
 Fig. 4 Fig. 5

Q3. (a)

Fig. 6

The equilibrium (point E) is attained when the two forces of demand and supply balance without
the influence of external forces in a market, where demand meets the supply. Hence, the
equilibrium quantity of this oil market can be determined by equating the demand and supply
functions. (Fig. 6)
 Market Demand function is P = 800 − 2Q
Market Supply function is P = 200 + Q

800 - 2Q = 200 + Q
800 - 200 = Q + 2Q
600 = 3Q
Q = 200

At the equilibrium quantity, Q = 200, the price can be determined by substituting the equilibrium
quantity into the market supply or the market demand function.

Market Demand Function Market Supply Function

P = 800 − 2Q P = 200 + Q
where Q =200, therefore where Q =200, therefore
P = 800 - 2(200) P = 200 + (200)
P = 800 - 400 P = $400
P = $400

So, the market equilibrium price from the above calculations would be $400 and the market
equilibrium quantity from the above calculations would be 200 barrels of oil per day.
Q3. (b)

Fig. 7

The following are the calculations for;

(I) Producer Surplus (Fig. 5)

(II) Consumer Surplus (Fig. 5)
(III) Total Surplus (Fig. 5)

Consumer Surplus is marked as the green area in the graph. It can be calculated using the formula
for the area of a triangle. (Fig. 7)

Consumer Surplus = (800-400) x 200

2
Consumer Surplus = 80,000
2
Consumer Surplus = $40,000

Producer Surplus is marked by the red area in the graph. It can be calculated using the formula for
the area of a triangle. (Fig. 7)
So, Producer Surplus is equal to:

Producer Surplus = (400-200) x 200

2
Producer Surplus = 40,000
2
Producer Surplus = $20,000
 The total (community) surplus for both consumers and producers is equals to:

Consumer Surplus + Producer Surplus

40,000 + 20,000 = $60,000

The market is functioning at the equilibrium, at its allocatively efficient point.

The assumptions made for this conclusion on the equilibrium are:
● It is a closed economy, without having the influence of trade.
● None of the three oil suppliers have the ability to influence the market price.
● There are no externalities resulting from trade in the oil market.

The resources are being allocated efficiently as;

a. the output of production is at the marginal cost.
b. the price the consumers are willing to pay is equal to the marginal benefit they derive from
the good or the service.

Hence, there is a balance in the forces of supply and demand as everyone in this market is allocating
their resources. The market is efficient as there is no way to improve the situation of both the
consumers and suppliers without imposing a cost on the other.