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Problem Set 1 Answer - Department of Economics University...

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1 Department of Economics Prof. Kenneth Train University of California, Berkeley Fall 2008 ECONOMICS 1 Problem Set 1 – Suggested Answers 1) a) b) The opportunity cost of these 200 llamas is the number of bushels of grapes that you must forgo in order to get these 200 llamas. If you weren’t producing any llamas, you could produce 125,000 bushels of grapes. Now you are producing only 115,000. So the opportunity cost of these 200 llamas is 10,000 bushels of grapes . c) The PPF is bowed outward due to the law of increasing opportunity costs. Imagine you are producing at point A in the graph of part a). There you produce only grapes using all of your land. Now you want to consider raising 200 llamas (which means moving to point B). To raise llamas, you must allocate some land for grazing by the llamas and can’t produce grapes on that part of your land. Since llamas graze equally well on any kind of land, you will allocate the areas that are least good for grapes, that is, the rocky, hilly areas; production of grapes will be reduced by only 10,000 bushels. But suppose now that you are producing at point D and want to increase your production of llamas by 200 again. You will have to allocate more land to the grazing of the llamas, probably some of the flat loamy areas since you are already producing 600 llamas. Those areas are better for producing grapes and the reduction in the production of grapes is larger: it goes from producing 70,000 bushels to only 40,000. The opportunity cost of these additional 200 llamas is now 30,000 bushels of grapes, 3 times larger than before. Since the slope of the PPF represents this opportunity cost, its shape shows that the higher the production of llamas (good on the x-axis) the higher the number of bushels of grapes (good on the y-axis) you 125 115 95 70 40 0 Grapes (thousands) Llamas 0 200 400 600 800 1000 A B C D E F

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2 must forgo to produce some additional number of llamas; that is, the higher the opportunity cost of llamas in terms of grapes. If you draw the line tangent to points B and E in your graph, you will see that the second line is steeper than the first, which means that the slope is higher, showing higher opportunity costs. d) Given your current production levels (point B), the opportunity costs of producing 200 more llamas is 20,000 bushels of grapes (you go from producing 115,000 bushels to producing only 95,000). That is, if you produce 200 more llamas you must produce 20,000 fewer bushels of grapes. The 200 extra llamas would increase your revenues by \$24,000 (\$120 each times 200).
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Problem Set 1 Answer - Department of Economics University...

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