Bahria University

Islamabad Campus
Department of Business Studies
Problem Set 1, 2 and 3

1. 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.
a. Selena pays a storekeeper $1 for a quart of milk.
b. Stuart earns $4.50 per hour working at a fastfood restaurant.
c. Shanna spends $30 to get a haircut.
d. Sally earns $10,000 from her 10 percent owner ship of Acme Industrial.

2. Imagine a society that produces military goods and consumer goods, which we’ll call
“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.
b. Show a point that is impossible for the economy to achieve. Show a point that is
feasible but inefficient.
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 the
Doves might choose.
d. Imagine that an aggressive neighbouring 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.

3. An economy consists of three workers: Larry, Moe, and Curly. Each works ten 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)
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.
 d. Are any of the allocations calculated in part (a) inefficient? Explain

4. Classify the following topics as relating to microeconomics or macroeconomics.

a. a family’s decision about how much income to save
b. the effect of government regulations on auto emissions
c. the impact of higher national saving on economic growth
d. a firm’s decision about how many workers to hire
e. the relationship between the inflation rate and changes in the quantity of money

5. Classify each of the following statements as positive or normative. Explain.

a. Society faces a short-run trade-off between inflation and unemployment.
b. A reduction in the rate of money growth will reduce the rate of inflation.
c. The Federal Reserve should reduce the rate of money growth.
d. Society ought to require welfare recipients to look for jobs.
e. Lower tax rates encourage more work and more saving.

6. An average worker in Brazil can produce an ounce of soybeans in 20 minutes and an

ounce of coffee in 60 minutes, while an average worker in Peru can produce an ounce of
soybeans in 50 minutes and an ounce of coffee in 75 minutes.
a. Who has the absolute advantage in coffee? Explain.
b. Who has the comparative advantage in coffee? Explain.
c. If the two countries specialize and trade with each other, who will import coffee?
Explain.
d. Assume that the two countries trade and that the country importing coffee trades 2
ounces of soybeans for 1 ounce of coffee. Explain why both countries will benefit
from this trade.
7. The market for pizza has the following demand and supply schedules:
Price (Rs.) 400 500 600 700 800 900
Quantity Demanded 135 104 81 68 53 39
Quantity Supplied 26 53 81 98 110 121

a. Graph the demand and supply curves. What is the equilibrium price and quantity
in this market?
b. If the actual price in this market were above the equilibrium price, what would
drive the market toward the equilibrium?
c. If the actual price in this market were below the equilibrium price, what would
drive the market toward the equilibrium?

8. Consider the following events: Scientists reveal that consumption of oranges decreases
the risk of diabetes, and at the same time, farmers use a new fertilizer that makes orange
trees more productive. Illustrate and explain what effect these changes have on the
equilibrium price and quantity of oranges.
9. Market research has revealed the following information about the market for chocolate
bars: The demand schedule can be represented by the equation QD = 1,600 – 300P, where
QD is the quantity demanded and P is the price. The supply schedule can be represented
by the equation QS = 1,400 + 700P, where QS is the quantity supplied. Calculate the
equilibrium price and quantity in the market for chocolate

10. Ketchup is a complement (as well as a condiment) for burgers. If the price of burgers
rises, what happens to the market for ketchup? For tomatoes? For tomato juice? For
orange juice?

11. Consider the market for minivans. For each of the events listed here, identify which of
the determinants of demand or supply are affected. Also indicate whether demand or
supply increases or decreases. Then draw a diagram to show the effect on the price and
quantity of minivans.
a. People decide to have more children.
b. A strike by steelworkers raises steel prices.
c. Engineers develop new automated machinery for the production of minivans.
d. The price of sports utility vehicles rises.
e. A stock-market crash lowers people’s wealth.