PS02__Answers_ - EC 340 Spring 2011 Problem Set 2 1. Here...

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Unformatted text preview: EC 340 Spring 2011 Problem Set 2 1. Here are some prices from the grocery store: Bread $2.00 Peanut Butter $3.00 Milk $5.00 Soap $4.00 What is the price of Milk in terms of Bread? What is the price of Peanut Butter in terms of Soap? By definition, the price of X in terms of Y is written as PX/PY. So the price of Milk in terms of Bread is $5.00/$2.00 = 2 ½ , and the price of Peanut Butter in terms of Soap is $3.00/$4.00 = ¾ How many Bread can be traded for 10 Peanut Butter? 10 Peanut Butter have a value of $30. Since each loaf of bread has a price of $2.00, 15 loaves would have a value of $30. Then 10 Peanut Butter has the same value as 15 Bread, or 15 Bread can be traded for 10 Peanut Butter. 2. Consider a Ricardian, two‐good (Snow Boards and MP3 Players) economy with the following data regarding technology and labor supply: Snow Boards produced per worker: 10 MP3 Players produced per worker: 20 Total labor supply: 400 Draw the production possibilities frontier for this economy. QSnowboards QMP3 8,000 Either one of these is correct 4,000 QSnowboards 8,000 QMP3 4,000 3. 4. 5. Given the information in question 2, what is the equilibrium price of Snow Boards in terms of MP3 Players in the absence of trade? In the absence of trade, the equilibrium price of Snow Boards in terms of MP3 players equals the opportunity cost of producing each extra Snow Board. In this case, that would be 2 MP3 players. Assume that this economy could trade with the rest of the world at a price of Snow Boards in terms of MP3 Players equal to 4. How many Snowboards and MP3 Players will this economy produce? Since the opportunity cost of Snow Boards is only 2 MP3 Players, but the price of Snow Boards in terms of MP3 Players is 4, the economy would produce as many Snow Boards as possible. In this case, the economy would specialize to the production of Snow Boards, producing 4,000 Snow Boards and zero MP3 players. Given the information in questions 2 and 4, show the consumption possibilities frontier for this economy if it trades with the rest of the world. Compare this frontier to the consumption possibilities frontier if this economy does not trade with the rest of the world. The consumption possibilities without trade is just given by the PPF. With trade, the economy produces only Snow Boards and trades for whatever MP3 players that it wants. At a price of Snow Boards in terms of MP3 players = 4, the economy could export all 4,000 Snow Boards, importing 16,000 MP3 players in return. QSnowboards QMP3 16,000 Either one of these is correct 8,000 4,000 QSnowboards 8,000 16,000 QMP3 4,000 6. Call the country described in question 2 Home. Consider a second country, called Foreign, with the following information: Snow Boards produced per worker: 2 MP3 Players produced per worker: 12 Total labor supply: 2,000 7. Which country has an absolute advantage in producing Snow Boards? Which country has a comparative advantage in producing Snow Boards? Which has an absolute advantage in producing MP3 Players? Which has a comparative advantage in producing MP3 Players? Home has the absolute advantage in producing both goods since each Home worker can produce more Snow Boards thaneach Foreign worker, and each Home worker can produce more MP3 players than each Foreign worker. Home has the comparative advantage in Snow Boards since the opportunity cost of producing Snow Boards in Home is 2 MP3 players. This compares with an opportunity cost in Foreign of 6 MP3 players (either draw the Foreign PPF, or recognize that each Foreign Snow Board requires ½ worker, and ½ worker could produce 12/2 = 6 MP3 players). Since Home has the comparative advantage in Snow Boards, Foreign has the comparative advantage in MP3 players. Suppose that labor is reallocated within each of the two countries to produce more of one good and less of another. The table below shows the change in the production of each of the two goods in each of the two countries, as well as the total world change in production. Finish filling out the table. Snow Boards MP3 Players Change in Home +40 ‐80 Change in Foreign ‐20 +120 Change in World +20 +40 Producing 40 more Snow Boards at Home requires 4 workers. Take these workers out of MP3 player production and lose 80 MP3 players (20 MP3 Players per worker). Likewise, 120 extra MP3 players in Foreign require 10 workers. Take these 10 workers out of Snow Board production and lose 20 Snow Boards (2 Snow Boards per worker). ...
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This note was uploaded on 11/11/2011 for the course EC 340 taught by Professor Ballie during the Spring '10 term at Michigan State University.

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