SOLUTION 1

(a)
Avalon's decision to hire 15 more employees is a short-run decision, while its
decision to move to a larger space is a long-run decision.

Short-run decisions are made within a period of time in which at least one factor
of production is fixed. In Avalon's case, the fixed factor of production in the short run is
its physical space.
Long-run decisions are made within a period of time in which all factors of
production can be varied. In Avalon's case, it can vary its physical space in the long run.

Turn Over
 (b)

Avalon's long-run decision to move to a larger space is riskier than its short-run decision to
hire 15 more employees because it is more difficult to reverse.
If Avalon hires 15 more employees and then finds that it does not need them, it can simply
lay them off. However, if Avalon moves to a larger space and then finds that it does not need
the extra space, it may be difficult to sublease the space or find a new tenant. Additionally,
Avalon will have to pay the higher rent on the larger space even if it is not using it to its full
capacity.
In general, long-run decisions are riskier than short-run decisions because they involve more
commitment and are more difficult to reverse.
Here is a table that summarizes the key differences between short-run and long-run
decisions:

Characteristic Short-run decision Long-run decision

Time frame Shorter Longer

Fixed factors of At least one factor All factors of

production of production is fixed production can be varied

More difficult to
Reversibility Easier to reverse reverse

Risk Less risky More risky

Overall, Avalon's decision to move to a larger space is a long-run decision that is

riskier than its short-run decision to hire 15 more employees. However, the long-run
decision could be beneficial for Avalon if it allows the company to grow and expand its
operations.

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SOLUTION 2

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 Changes in the demand for and supply of loanable funds can change the real
interest rate and quantity of loanable funds in the following ways:

Increase in demand for loanable funds:

 If the demand for loanable funds increases, the real interest rate will increase.

This is because borrowers are willing to pay more to borrow money when there is
more demand for it.

 The quantity of loanable funds demanded will also increase. This is because

borrowers are willing to borrow more money when the interest rate is higher.

Decrease in demand for loanable funds:

 If the demand for loanable funds decreases, the real interest rate will

decrease. This is because borrowers are willing to pay less to borrow money when
there is less demand for it.

 The quantity of loanable funds demanded will also decrease. This is because

borrowers are willing to borrow less money when the interest rate is lower.

Increase in supply of loanable funds:

 If the supply of loanable funds increases, the real interest rate will decrease.

This is because lenders are willing to lend money at a lower interest rate when there is
more supply of it.

 The quantity of loanable funds supplied will also increase. This is because

lenders are willing to lend more money when the interest rate is lower.

Decrease in supply of loanable funds:

 If the supply of loanable funds decreases, the real interest rate will increase.

This is because lenders are willing to lend money at a higher interest rate when there
is less supply of it.

 The quantity of loanable funds supplied will also decrease. This is because

lenders are willing to lend less money when the interest rate is higher.

Example:

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 Suppose that the government decides to increase its spending on infrastructure
projects. This will increase the demand for loanable funds, as the government will need to
borrow money to finance its spending. As a result, the real interest rate will increase and the
quantity of loanable funds demanded will increase.

Another example is when the central bank decides to raise interest rates. This will
decrease the supply of loanable funds, as lenders will be less willing to lend money at a
higher interest rate. As a result, the real interest rate will increase and the quantity of
loanable funds supplied will decrease.

Conclusion:

Changes in the demand for and supply of loanable funds can have a significant
impact on the real interest rate and quantity of loanable funds. These changes can have a
ripple effect throughout the economy, affecting investment, consumption, and economic
growth.

SOLUTION 3

A change in the supply of money can change the interest rate in the following
ways:

Increase in money supply:

 If the money supply increases, the interest rate will decrease. This is because

there is more money available to lend, so lenders are willing to lend money at a lower
interest rate.

Decrease in money supply:

 If the money supply decreases, the interest rate will increase. This is because

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 there is less money available to lend, so lenders are willing to lend money at a higher
interest rate.

This is because the interest rate is the price of money. When the money supply
increases, the price of money decreases. When the money supply decreases, the price of
money increases.

Example:

Suppose that the central bank decides to increase the money supply by buying
government bonds. This will inject more money into the economy and increase the supply of
loanable funds. As a result, the interest rate will decrease.

Another example is when the central bank decides to decrease the money supply by
selling government bonds. This will drain money from the economy and decrease the supply
of loanable funds. As a result, the interest rate will increase.

Conclusion:

A change in the supply of money can have a significant impact on the interest rate.
The central bank can use this tool to manage the economy and promote economic growth.

It is important to note that the relationship between the money supply and interest
rate is not always straightforward. There are other factors that can also affect the interest
rate, such as inflation expectations and economic growth.

SOLUTION 4

The real exchange rate (RER) is defined as the ratio of the nominal exchange rate to the

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relative price level between two countries. In this case, the RER between New Zealand and
Japan is defined as follows:
RER = E * P* / P
Where:
 E is the nominal exchange rate in yen per dollar
 P* is the Japanese price level
 P is the New Zealand price level
The real exchange rate tells us how much more expensive or cheaper goods and services are
in one country relative to another, taking into account the exchange rate. For example, if the
RER between New Zealand and Japan is equal to 1, then goods and services are equally
expensive in both countries. If the RER is greater than 1, then goods and services are
cheaper in New Zealand. If the RER is less than 1, then goods and services are more
expensive in New Zealand.
The real exchange rate is determined by a number of factors, including:
 Relative productivity: If New Zealand is more productive than Japan, then New Zealand
will produce goods and services at a lower cost. This will make New Zealand exports more
competitive and lead to an appreciation of the New Zealand dollar.
 Relative inflation rates: If inflation is higher in New Zealand than in Japan, then New
Zealand goods and services will become more expensive relative to Japanese goods and
services. This will lead to a depreciation of the New Zealand dollar.
 Interest rates: If interest rates are higher in New Zealand than in Japan, then investors
will be more attracted to New Zealand assets. This will lead to an appreciation of the New
Zealand dollar.
 Government intervention: Governments can intervene in the foreign exchange market
to try to influence the value of their currency. For example, the Japanese government may
buy yen to try to weaken the yen and make Japanese exports more competitive.
The nominal exchange rate is the price of one currency in terms of another currency. It is
determined by the supply and demand for currencies. The supply of currencies is
determined by factors such as trade flows and investment flows. The demand for currencies
is determined by factors such as tourism and speculation.
The nominal exchange rate is also influenced by the real exchange rate. For example, if the
real exchange rate between New Zealand and Japan appreciates, then the New Zealand

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 dollar will appreciate relative to the Japanese yen. This is because investors will be more
attracted to New Zealand assets if New Zealand goods and services are cheaper relative to
Japanese goods and services.
In conclusion, the real exchange rate is determined by a number of factors, including relative
productivity, relative inflation rates, interest rates, and government intervention. The
nominal exchange rate is determined by the supply and demand for currencies, and is also
influenced by the real exchange rate.

SOLUTION 5.

5a).

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 Without international trade, the price of a container of roses in New Zealand would
be determined by the intersection of the domestic demand and supply curves. The
intersection occurs at a price of $175 per container and a quantity of 6 million containers per
year.

This is because at a price of $175, wholesalers are willing to buy 6 million containers
of roses per year and New Zealand rose growers are willing to supply 6 million containers of
roses per year. At any other price, there would be a surplus or a shortage of roses.

Explanation:

Surplus: If the price were above $175, there would be a surplus of roses, as
wholesalers would be willing to buy fewer roses and New Zealand rose growers would be
willing to supply more roses.

Shortage: If the price were below $175, there would be a shortage of roses, as
wholesalers would be willing to buy more roses and New Zealand rose growers would be
willing to supply fewer roses.

Therefore, the equilibrium price and quantity of roses in New Zealand without
international trade would be $175 per container and 6 million containers per year.

Note: The fact that wholesalers in New Zealand can buy roses from Holland for $125
per container is irrelevant to the domestic market equilibrium price and quantity without
international trade.

5b)

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 At a price of $175 per container, the rest of the world has a comparative advantage
in producing roses. This is because the world market price of roses is $125 per container,
which is lower than the domestic market equilibrium price in New Zealand.

This means that New Zealand rose growers can produce roses at a higher opportunity
cost than rose growers in the rest of the world. In other words, New Zealand rose growers
have to give up more other goods and services to produce a container of roses than rose
growers in the rest of the world.

Therefore, New Zealand should specialize in producing goods and services in which it
has a comparative advantage and import roses from the rest of the world.

Explanation:

Comparative advantage: A country has a comparative advantage in producing a good or

service if it can produce it at a lower opportunity cost than any other country.
Opportunity cost: The opportunity cost of producing a good or service is the value of the
next best alternative that is given up.

Example:

Suppose that New Zealand can produce a container of roses at an opportunity cost of
10 loaves of bread and the rest of the world can produce a container of roses at an
opportunity cost of 8 loaves of bread. This means that New Zealand has a comparative
disadvantage in producing roses.

If New Zealand specializes in producing bread and imports roses from the rest of the
world, then it can consume more roses and bread than if it produced both roses and bread
itself. This is because New Zealand can produce bread at a lower opportunity cost than
roses.

Therefore, New Zealand should specialize in producing goods and services in which it
has a comparative advantage and import goods and services in which it has a comparative
disadvantage.

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 5c)

If New Zealand wholesalers buy roses at the lowest possible price, they will buy all
of their roses from the world market. This is because the world market price of roses is
$125 per container, which is lower than the domestic market equilibrium price in New
Zealand.

Therefore, New Zealand wholesalers will buy 0 containers of roses from local
growers and import 6 million containers of roses from the world market.

Explanation:

 World market price: The world market price of a good is the price at
which the good is bought and sold in the world market.

 Domestic market equilibrium price: The domestic market equilibrium

price of a good is the price at which the quantity demanded equals the quantity
supplied in the domestic market.

In this case, the world market price of roses is lower than the domestic market
equilibrium price in New Zealand. This means that New Zealand wholesalers can buy roses
more cheaply from the world market than from the domestic market.

Therefore, New Zealand wholesalers will buy all of their roses from the world
market.

Note: This is a simple example of international trade. In reality, there are other
factors that can affect trade decisions, such as transportation costs and tariffs. However,
the basic principle is the same: wholesalers will buy from the market where the price is
lowest.

5d).

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 Who gains from free international trade in roses:

 New Zealand rose consumers: New Zealand rose consumers will gain
from free international trade in roses because they will be able to buy roses at a
lower price. This is because the world market price of roses is $125 per container,
which is lower than the domestic market equilibrium price in New Zealand.

 New Zealand rose importers: New Zealand rose importers will gain
from free international trade in roses because they will be able to make a profit by
buying roses from the world market and selling them in the New Zealand market at
a higher price.

Who loses from free international trade in roses:

 New Zealand rose growers: New Zealand rose growers will lose from
free international trade in roses because they will not be able to compete with the
lower prices of roses from the world market. As a result, some New Zealand rose
growers may go out of business.

Overall:

New Zealand rose consumers and New Zealand rose importers will gain from free
international trade in roses. New Zealand rose growers will lose from free international
trade in roses.

Note: It is important to note that the gains and losses from free international trade
are not evenly distributed. Some people gain more than others, and some people lose
more than others.

5e)

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 If a tariff of $25 per container is imposed on imports of roses, the following will
happen:

 Price of roses in New Zealand will increase: The tariff will increase the cost of

imported roses, which will lead to an increase in the price of roses in New Zealand.

 Quantity of roses bought will decrease: At a higher price, consumers will

demand fewer roses.

 Quantity produced locally will increase: At a higher price, New Zealand rose

growers will be able to make a profit by producing more roses.

 Quantity imported will decrease: At a higher price, New Zealand wholesalers

will import fewer roses.

Explanation:

A tariff is a tax on imports. It is a protectionist measure that is designed to make

domestic goods more competitive.

In this case, the tariff on imports of roses will make New Zealand roses more
competitive. This is because the tariff will increase the price of imported roses, which will
make New Zealand roses relatively cheaper.

As a result, New Zealand rose growers will be able to sell more roses at a higher
price. This will lead to an increase in the quantity of roses produced locally.

However, the tariff will also make roses more expensive for New Zealand consumers.
This will lead to a decrease in the quantity of roses bought.

Finally, the tariff will make imported roses more expensive for New Zealand
wholesalers. This will lead to a decrease in the quantity of roses imported.

Overall:

A tariff on imports of roses will lead to an increase in the price of roses in New
Zealand, a decrease in the quantity of roses bought, an increase in the quantity produced
locally, and a decrease in the quantity imported.

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 5f)

The following people gain from the tariff on imports of roses:

 New Zealand rose growers: New Zealand rose growers will gain from the tariff
because they will be able to sell more roses at a higher price. This is because the tariff will
make imported roses more expensive, which will make New Zealand roses relatively
cheaper.

The following people lose from the tariff on imports of roses:

 New Zealand rose consumers: New Zealand rose consumers will lose from the
tariff because they will have to pay more for roses. This is because the tariff will increase the
price of roses in New Zealand.

 New Zealand rose importers: New Zealand rose importers will lose from the
tariff because they will make less profit. This is because the tariff will increase the cost of
imported roses.

Overall:

New Zealand rose growers gain from the tariff, while New Zealand rose consumers
and New Zealand rose importers lose from the tariff.

Note: It is important to note that the gains and losses from the tariff are not evenly
distributed. New Zealand rose growers will gain significantly, while New Zealand rose
consumers and New Zealand rose importers will lose significantly.

SOLUTION 6

6a)

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 Sara's real income in terms of smoothies is the amount of smoothies she can buy
with her income. When her income falls, she can buy fewer smoothies, even though the
price of smoothies remains unchanged.

To calculate Sara's real income in terms of smoothies, we divide her income by the
price of a smoothie:

Real income in terms of smoothies = Income / Price of a smoothie

When Sara's income falls from $1,200 to $900, her real income in terms of smoothies
falls from 100 smoothies ($1,200 / $12) to 75 smoothies ($900 / $12).

Therefore, the fall in Sara's income reduces her real income in terms of smoothies by
25 smoothies.

6b)

Sara's real income in terms of popcorn is the amount of popcorn she can buy with
her income. When her income falls, she can buy less popcorn, even though the price of
popcorn remains unchanged.

To calculate Sara's real income in terms of popcorn, we divide her income by the
price of a bag of popcorn:

Real income in terms of popcorn = Income / Price of a bag of popcorn

When Sara's income falls from $1,200 to $900, her real income in terms of popcorn
falls from 100 bags of popcorn ($1,200 / $12) to 75 bags of popcorn ($900 / $12).

Therefore, the fall in Sara's income reduces her real income in terms of popcorn by
25 bags of popcorn.

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 6c)

The relative price of a smoothie in terms of popcorn is the number of bags of

popcorn that Sara must give up to buy one smoothie. When Sara's income falls, the relative
price of a smoothie in terms of popcorn remains unchanged.

To calculate the relative price of a smoothie in terms of popcorn, we divide the price
of a smoothie by the price of a bag of popcorn:

Relative price of a smoothie in terms of popcorn = Price of a smoothie / Price of a bag

of popcorn

The relative price of a smoothie in terms of popcorn is equal to 1, because the price
of a smoothie and the price of a bag of popcorn are both $12.

Therefore, the fall in Sara's income has no effect on the relative price of a smoothie
in terms of popcorn.

6d)

The slope of Sara's budget line is equal to the negative of the relative price of a
smoothie in terms of popcorn. This is because the slope of the budget line represents the
trade-off between smoothies and popcorn.

Since the relative price of a smoothie in terms of popcorn remains unchanged, the
slope of Sara's new budget line also remains unchanged.

Therefore, the slope of Sara's new budget line remains unchanged if the budget line
is drawn with smoothies on the x-axis.

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