2009 - summer - midterm - solutions

# For a given relative price if the relative price is

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For a given relative price, if the relative price is greater than the opportunity cost of the good, then more of that good should be produced. But as production of the good increases the opportunity cost of production will increase and eventually the relative price will equal the opportunity cost so it will not be value-maximizing 4

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to raise production beyond this point. p 1 /p 2 Good 2 Good 1 p 1 /p 2 (b) The opportunity cost of cheese is a LC a LW : With an increase in the size of the Labour force, there will be an expansion of the PPF but there be no change to the opportunity cost of producing cheese. W PPF 0 C PPF 1 The Home country specializes in the production of Cheese. With an increase in Labour at home from L to L 0 the amount of Cheese produced by Home increases to L 0 a LC : There is no change to opportunity costs of Cheese production in either Home or Foreign so the horizontal portions of the RS function will remain the same. But the location of the vertical portion of the RS function will shift to the right since with L 0 a LC > L a LC L 0 a LC L ° a LW > L a LC L ° a LW 5