ECON 200.

Introduction to Microeconomics Homework 1

Name:________________________________________

[Multiple Choice]

1. Your opportunity cost of going to a movie is (c)

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.

2. A marginal change is one that (b)

a. is not important for public policy.
b. incrementally alters an existing plan.
c. makes an outcome inefficient.
d. does not influence incentives.

3. Adam Smith’s “invisible hand” refers to (b)

a. the subtle and often hidden methods that businesses use to profit at consumers??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.

4. Governments may intervene in a market economy in order to (d)

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.

5. A point inside the production possibilities frontier is (b)

a. efficient, but not feasible.
b. feasible, but not efficient.
c. both efficient and feasible.
d. neither efficient nor feasible.

6. Which of the following is a positive, rather than a normative, statement? (a)

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 should veto law X.
7. In an hour, David can wash 2 cars or mow 1 lawn, and Ron can wash 3 cars or mow 1 lawn. Who has
the absolute advantage in car washing, and who has the absolute advantage in lawn mowing? (d)
a. David in washing, Ron in mowing.
b. Ron in washing, David in mowing.
c. David in washing, neither in mowing.
d. Ron in washing, neither in mowing.

8. Once again, in an hour, David can wash 2 cars or mow 1 lawn, and Ron can wash 3 cars or mow 1 lawn.
Who has the comparative advantage in car washing, and who has the comparative advantage in lawn
mowing? (b)
a. David in washing, Ron in mowing.
b. Ron in washing, David in mowing.
c. David in washing, neither in mowing.
d. Ron in washing, neither in mowing.

9. Suppose that in the United States, producing an aircraft takes 10,000 hours of labor and producing a
shirt takes 2 hours of labor. In China, producing an aircraft takes 40,000 hours of labor and producing a
shirt takes 4 hours of labor. What will these nations trade? (b)
a. China will export aircraft, and the United States will export shirts.
b. China will export shirts, and the United States will export aircraft.
c. Both nations will export shirts.
d. There are no gains from trade in this situation.

10. Mark can cook dinner in 30 minutes and wash the laundry in 20 minutes. His roommate takes half as
long to do each task. How should the roommates allocate the work? (d)
a. Mark should do more of the cooking based on his comparative advantage.
b. Mark should do more of the washing based on his comparative advantage.
c. Mark should do more of the washing based on his absolute advantage.
d. There are no gains from trade in this situation.
[Short Answer]

1. 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. If you have just 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 quite low. The point is that
even the necessities of life, like water, do not always have large marginal benefits.

2. 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.
If you are thinking of going skiing instead of working at your part-time job, the cost of skiing
includes its monetary and time costs, which includes the opportunity cost of the wages you are giving up
by not working. If the choice is between skiing and going to the library to study, then the cost of skiing is
its monetary and time costs including the value of time spent studying.

3. You win $100 in a basketball pool. You have a choice between spending the money now and putting it
away for a year in a bank account that pays 5 percent interest. What is the opportunity cost of spending
the $100 now?
If you spend $100 now instead of saving it for a year and earning 5 percent interest, you are
giving up the opportunity to spend $105 one year from now.

4. The company that you manage has invested $5 million in developing a new product, but the
development is not quite finished. At a recent meeting, your salespeople report that the introduction of
competing products has reduced the expected sales of your new product to $3 million. If it would cost
$1 million to finish development and make the product, should you go ahead and do so? What is the
most that you should pay to complete development?.
The fact that you have already sunk $5 million is not relevant to your decision anymore, because
that money is gone. What matters now is the chance to earn profits at the margin. If you spend another
$1 million and can generate sales of $3 million, you’ll earn $2 million in marginal profit, so you should do
so. You are right to think that the project has lost a total of $3 million ($6 million in costs and only $3
million in revenue) and you should not have started it. However, if you do not spend the additional $1
million, you will not have any sales and your losses will be $5 million. So what matters here is trying to
minimize your loss. In fact, you would pay up to $3 million to complete development; any more than
that, and you will not be increasing profit at the margin.
5. Explain whether each of the following government activities 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

Efficiency: The market failure comes from the market power of the cable TV firm

b. providing some poor people with vouchers that can be used to buy food
Equity

c. prohibiting smoking in public places

Efficiency: An externality arises because secondhand smoke harms nonsmokers

d. breaking up Standard Oil (which once owned 90 percent of all oil refineries) into several smaller
companies
Efficiency: The market failure occurs because of Standard Oil’s market power

e. imposing higher personal income tax rates on people with higher incomes
Equity

f. instituting laws against driving while intoxicated

Efficiency: There is an externality because of accidents caused by drunk drivers.

6. Explain Draw and explain a production possibilities frontier for an economy that produces milk and
cookies. What happens to this frontier if disease kills half of the economy’s cows?
The following figure shows a production possibilities frontier between milk and cookies (PPF1). If
a disease kills half of the economy's cow population, less milk production is possible, so the PPF shifts
inward (PPF2). Note that if the economy produces all cookies, it does not need any cows and production
is unaffected. But if the economy produces any milk at all, then there will be less production possible
after the disease hits.
7. Imagine a society that produces military goods and consumer goods, which we’ll “guns” and “butter.”

a. 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.
The following figure shows a production possibilities frontier between guns and butter. It is
bowed out because of the law of increasing opportunity costs. As the economy moves from producing
many guns and a little butter (point H) to producing fewer guns and more butter (point D), the
opportunity cost of each additional unit of butter increases because the resources best suited to
producing guns are shifting toward the production of butter. Thus, the number of guns given up to
produce one more unit of butter is increasing

b. Show a point that is impossible for the economy to achieve. Show a point that is feasible but
inefficient.
Point A is impossible for the economy to achieve; it is outside the production possibilities
frontier. Point B is feasible but inefficient because it is inside the production possibilities frontier

c. 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.
The Hawks might choose a point like H, with many guns and not much butter. The Doves might
choose a point like D, with a lot of butter and few guns.

d. 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 Hawks and Doves reduced their desired quantity of guns by the same amount, the Hawks
would get a bigger peace dividend because the production possibilities frontier is much flatter at point H
than at point D. As a result, the reduction of a given number of guns, starting at point H, leads to a much
larger increase in the quantity of butter produced than when starting at point D.
8. The first principle of economics discussed in Chapter 1 is that people face trade-offs. Use a production
possibilities frontier to illustrate society’s trade-off between two “goods” - clean environment and the
quantity of 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 shape and position of the frontier depend on how costly it is to maintain a clean
environmentthe productivity of the environmental industry. Gains in environmental productivity, such
as the development of new way to produce electricity that emits fewer pollutants, lead to shifts of the
production-possibilities frontier, like the shift from PPF1 to PPF2 shown in the figure.

9. 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.

a. Calculate how much of each service is produced under the following circumstances, which we label A,
B, C, and D:
- All three spend all their time mowing lawns. (A)
- All three spend all their time washing cars. (B)
- All three spend half their time on each activity. (C)
- Larry spends half his time on each activity, while Moe only washes cars and Curly only mows lawns. (D)

A: 40 lawns mowed; 0 washed cars

B: 0 lawns mowed, 40 washed cars
C: 20 lawns mowed; 20 washed cars
D: 25 lawns mowed; 25 washed cars
b. Graph the production possibilities frontier for this economy. Using your answers to part (a), identify
points A, B, C, and D on your graph.

c. Explain why the production possibilities frontier has the shape it does.
Larry is equally productive at both tasks. Moe is more productive at washing cars, while Curly is
more productive at mowing lawns

d. Are any of the allocations calculated in part (a) inefficient? Explain.

Allocation C is inefficient. More washed cars and mowed lawns can be produced by simply
reallocating the time of the three individuals

10. Under what conditions is the production possibilities frontier linear rather than bowed out?
The production possibilities frontier will be linear if the opportunity cost of producing a good is
constant no matter how much of that good is produced. This will be most likely if the good is not
produced using specialized inputs.

11. 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.

a. Draw Maria’s production possibilities frontier for reading economics and sociology.
If Maria spends all 5 hours studying economics, she can read 100 pages, so that is the vertical
intercept of the production possibilities frontier. If she spends all 5 hours studying sociology, she can
read 250 pages, so that is the horizontal intercept. The opportunity costs are constant, so the
production possibilities frontier is a straight line.
b. What is Maria’s opportunity cost of reading 100 pages of sociology?
It takes Maria 2 hours to read 100 pages of sociology. In that time, she could read 40 pages of
economics. So the opportunity cost of 100 pages of sociology is 40 pages of economics

12. 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 100million workers.

a. For this situation, fill in the blanks.

Workers needed to make:

One Car One Ton of Grain
U.S. 1/4 1/10
Japan 1/4 1/5

b. Graph the production possibilities frontiers for the American and Japanese economies.
With 100 million workers and 4 cars per worker, if either economy were devoted completely to
cars, it could make 400 million cars. Because a U.S. worker can produce 10 tons of grain, if the United
States produced only grain it would produce 1,000 million tons. Because a Japanese worker can produce
5 tons of grain, if Japan produced only grain it would produce 500 million tons. These are the intercepts
of the production possibilities frontiers shown in the figure. Note that because the trade-off between
cars and grain is constant for both countries, the production possibilities frontiers are straight lines.
c. 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? Fill in the blanks

Opportunity Cost of:

One Car (in terms of tons One Ton of Grain (in
of grain given up) terms of cars given up)
U.S. 2 1/2 2/5
Japan 1 1/4 4/5

Because a U.S. worker produces either 4 cars or 10 tons of grain, the opportunity cost of one car
is 2 1/2 tons of grain, which is 10/4. Similarly, the U.S. opportunity cost of a ton of grain is 2/5 car (4
divided by 10). Because a Japanese worker produces either 4 cars or 5 tons of grain, the opportunity
cost of one car is 1 1/4 tons of grain, which is 5/4 and the Japanese opportunity cost of a ton of grain is
4/5 car

d. Which country has an absolute advantage in producing cars? In producing grain?

Neither country has an absolute advantage in producing cars, because they are equally
productive (the same output per worker); the United States has an absolute advantage in producing
grain, because it is more productive (greater output per worker).

e. Which country has a comparative advantage in producing cars? In producing grain?

Japan has a comparative advantage in producing cars, because it has a lower opportunity cost in
terms of grain given up. The United States has a comparative advantage in producing grain, because it
has a lower opportunity cost in terms of cars given up.
f. Without trade, half of each country’s workers produce cars and half produce grain. What quantities of
cars and grain does each country produce?
With half the workers in each country producing each of the goods, the United States would
produce 200 million cars (50 million workers times 4 cars each) and 500 million tons of grain (50 million
workers times 10 tons each). Japan would produce 200 million cars (50 million workers times 4 cars each)
and 250 million tons of grain (50 million workers times 5 tons each).

g. Starting from a position without trade, give an example in which trade makes each country better off.
From any situation with no trade, in which each country is producing some cars and some grain,
suppose the United States changed one worker from producing cars to producing grain. That worker
would produce 4 fewer cars and 10 additional tons of grain. Then suppose the United States offers to
trade 7 tons of grain to Japan for 4 cars. The United States will do this because the cost of producing 4
cars in the United States is 10 tons of grain. By trading, the United States can gain 4 cars for a cost of
only 7 tons of grain, so it is better off by 3 tons of grain. Suppose Japan changes one worker from
producing grain to producing cars. That worker would produce 4 more cars and 5 fewer tons of grain.
Japan will take the trade because it values 4 cars at 5 tons of grain, so it will be better off by 2 tons of
grain. With the trade and the change of one worker in both the United States and Japan, each country
gets the same amount of cars as before and both get additional tons of grain (3 for the United States
and 2 for Japan). Thus, by trading and changing their production, both countries are better off.

13. Pat and Kris are roommates. They spend most of their time studying (of course), but they leave some
time 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.

a. 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's opportunity cost of making a pizza is 1/2 gallon of root beer, because she could brew 1/2
gallon in the time (2 hours) it takes her to make a pizza. Kris's opportunity cost of making a pizza is 2/3
gallon of root beer, because she could brew 2/3 of a gallon in the time (4 hours) it takes her to make a
pizza. Pat has an absolute advantage in making pizza because she can make one in 2 hours, while it takes
Kris 4 hours. Because Pat's opportunity cost of making pizza is less than Kris', Pat has a comparative
advantage in making pizza.

b. If Pat and Kris trade foods with each other, who will trade away pizza in exchange for root beer?
Because Pat has a comparative advantage in making pizza, she will make pizza and exchange it
for root beer that Kris makes.

c. 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.
The highest price of pizza in terms of root beer that will make both roommates better off is 2/3
of a gallon of root beer. If the price were higher than that, then Kris would prefer making her own pizza
(at an opportunity cost of 2/3 of a gallon of root beer) rather than trading for pizza that Pat makes. The
lowest price of pizza in terms of root beer that will make both roommates better off is 1/2 gallon of root
beer. If the price were lower than that, then Pat would prefer making her own root beer (she can make
1/2 gallon of root beer instead of making a pizza) rather than trading for root beer that Kris makes.
14. The following table describes the production possibilities of two cities in the country of Baseballia:

Pairs of Red Socks per Pairs of White Socks

Worker per Hour per Worker per Hour
Boston 3 3
Chicago 2 1

a. Without trade, what is the price of white socks (in terms of red socks) in Boston? What is the price in
Chicago?
With no trade, 1 pair of white socks trades for 1 pair of red socks in Boston, because
productivity is the same for the two types of socks. The price in Chicago is 2 pairs of red socks per 1 pair
of white socks.

b. 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 an absolute advantage in the production of both types of socks, because a worker in
Boston produces more (3 pairs of socks per hour) than a worker in Chicago (2 pairs of red socks per hour
or 1 pair of white socks per hour).
Chicago has a comparative advantage in producing red socks, because the opportunity cost of
producing a pair of red socks in Chicago is 1/2 pair of white socks, while the opportunity cost of
producing a pair of red socks in Boston is 1 pair of white socks. Boston has a comparative advantage in
producing white socks, because the opportunity cost of producing a pair of white socks in Boston is 1
pair of red socks, while the opportunity cost of producing a pair of white socks in Chicago is 2 pairs of
red socks.

c. If the cities trade with each other, which color sock will each export?
If they trade socks, Boston will produce white socks for export, because it has the comparative
advantage in white socks, while Chicago produces red socks for export, which is Chicago's comparative
advantage.

d. What is the range of prices at which trade can occur?

Trade can occur at any price between 1 and 2 pairs of red socks per pair of white socks. At a
price lower than 1 pair of red socks per pair of white socks, Boston will choose to produce its own red
socks (at a cost of 1 pair of red socks per pair of white socks) instead of buying them from Chicago. At a
price higher than 2 pairs of red socks per pair of white socks, Chicago will choose to produce its own
white socks (at a cost of 2 pairs of red socks per pair of white socks) instead of buying them from Boston
15. 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.

a. 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.
The production possibilities frontiers for the two countries are shown in the figure. If, without
trade, a U.S. worker spends half of his time producing each good, the United States will have 50 shirts
and 10 computers. If, without trade, a worker in China spends half of his time producing each good,
China will have 50 shirts and 5 computers.

b. If these countries were open to trade, which country would export shirts? Give a specific numerical
example and show it on your graphs. Which country would benefit from trade? Explain.
China would export shirts because it has the lower opportunity cost of shirts. For China, the
opportunity cost of 1 shirt is 1/10 computer. For the United States, the opportunity cost of a shirt is 1/5
computer. Therefore, China has a comparative advantage in the production of shirts and the United
States has a comparative advantage in the production of computers.
The price of a shirt will fall between 1/5 and 1/10 of a computer. An example would be a price of
1/7 computer. Suppose China produced only shirts (100 shirts) and exported 50 shirts in exchange for
7.14 computers (50/7 = 7.14). This trade makes China better off than it was before trade (50 shirts and
5 computers). The United States would also benefit from this trade. If the United States produced only
computers (20 computers), and traded 7.14 of them to China for 50 shirts, the United States would have
12.86 (20-7.14) computers and 50 shirts and would be better off than before trade (10 computers and
50 shirts).

c. Explain at what price of computers (in terms of shirts) the two countries might trade.
The price of a computer would fall between 5 and 10 shirts. If the price were below 5, the
United States would not be willing to export computers because the opportunity cost of a shirt for the
United States is 1/5 computer. If the price were greater than 10 shirts, China would not be willing to
import computers because (for China) the opportunity cost of a computer is 10 shirts.
d. 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 well-being of the citizens of the two countries?
Once the productivity is the same in the two countries, the benefits of trade disappear. Trade is
beneficial because it allows countries to exploit their comparative advantage. If China and the United
States have exactly the same opportunity cost of producing shirts and computers, there will be no more
gains from trade available.