YOUR NAME:_______________________________ YOUR TAs NAME:___________________________ YOUR DISCUSSION #_____________

THE GEORGE WASHINGTON UNIVERSITY

Department of Economics

Economics 1011 Prof. Steve Suranovic Section 10 Spring 2015

Problem Set #2 – Answers Answer all of the following questions from the book and those below. HW #2 is due in class on Wednesday February 11th. A. Problems 1. Suppose Reggie has the following unit-labor requirements producing corn and wheat: aLC = 200 hrs per ton, aLW = 100 hours per ton. Nigel has the following unit-labor requirements: aLC = 300 hrs per ton, aLW = 120 hours per ton.

a. What  is  Reggie’s  productivity  in  wheat  production?  Include  units.        i. ProdWheat  =  1/aLW  =  1/100  =  .01  tons  per  hour  

 b. Demonstrate  that  Reggie  has  the  absolute  advantage  in  wheat  production  using  

productivity  comparisons.        

i. Nigel’s  productivity  in  wheat  is  1/aLW  =  1/120  =  .0083  tons  per  hour.    Because  Reggie’s  prod  at  .01  (from  part  a)  is  greater  than  Nigel’s  productivity  at  .0083,  Reggie  has  the  absolute  advantage  in  wheat.      

 c. Demonstrate  that  Reggie  has  the  absolute  advantage  in  corn  production  using  

unit  labor  requirement  comparisons.        

i. Because  Reggie’s  unit-­‐labor  requirement  in  corn  at  200  hrs  per  ton  is  less  than  Nigel’s  at  300  hours  per  ton,  Reggie  has  the  absolute  advantage  in  corn.      

 d. What  is  the  opportunity  cost  of  corn  production  for  Reggie?  

 i. aLC/aLW  =  200/100  =  2  tons  of  wheat  per  ton  of  corn  

 e. What  is  the  opportunity  cost  of  wheat  for  Nigel?  

 i. aLW/aLC  =  120/300  =  4/10  =  0.4  tons  of  corn  per  ton  of  wheat  

 f. Use  the  opportunity  cost  method  to  determine  who  has  the  comparative  

advantage  in  corn.    

i. Because  aLC/aLW  (Reggie)  =  200/100  =  2  tons  of  wheat  per  ton  of  corn    is  less  than  aLC/aLW  (Nigel)  =  300/120  =  2.5  tons  of  wheat  per  ton  of  corn,  Reggie  has  the  comparative  advantage  in  corn.      

 g. Use  the  relative  productivity  method  to  determine  who  has  the  comparative  

advantage  in  wheat.        

i. Nigel  is  ((1/120)/(1/100))  =  100/120  =  5/6th  as  productive  as  Reggie  in  wheat,  but  Nigel  is    ((1/300)/(1/200))  =  200/300  =  2/3rds    as  productive  as  Reggie  in  corn.    Because  Nigel  is  less  bad,  or  relatively  better  at  wheat  production,  he  has  the  comparative  advantage  in  wheat.            

2.      Suppose  that  in  one  day  Ling  can  produce  either  500  ice  cream  cones  or  1000  cups  of  coffee.    Simi  can  produce  either  400  ice  cream  cones  or  500  cups  of  coffee.    

a.    Who  has  the  absolute  advantage  in  the  production  of  coffee?  State  why.    

i.  Ling’s  coffee  productivity  at  1000  cups  per  day  is  greater  than  Simi’s  at  500  cups  per  day,  thus  Ling  has  the  absolute  advantage  in  coffee.      

 b.    What  is  Simi’s  opportunity  cost  of  coffee  production?    

i.    The  opportunity  cost  is  the  slope  of  the  PPF,  which  for  Simi  is  400/500  =  0.8  cones/cup            

    c.    Who  has  the  comparative  advantage  in  coffee  production?  State  why.    

i.    Ling  does  because  her  opportunity  cost  of  coffee  at  500/1000  =  0.5  cones/cup  is  less  than  Simi’s  at  0.8  cones  per  cup.        

d.    Draw  an  Edgeworth  box  diagram  with  right-­‐side-­‐up  Ling  and  upside-­‐down  Simi  when  both  specialize  in  their  comparative  advantage  goods.      Hint:  First,  determine  the  dimensions  of  the  box  =  total  amount  of  coffee  and  ice  cream.    Then  draw  the  PPFs        

     

e.    What  is  a  plausible  trading  terms  of  trade  (written  as  cones/cup)  that  could  make  both  Ling  and  Simi  better  off  through  trade?    

i.        Any  ToT  such  that,    0.5  cones/cup  <  ToT  <  0.8  cones  per  cup.    For  example,  0.7  cones  per  cup.  

500

1000

500 4000

Simi

Ling Coffee cups

Ice

crea

m c

ones

cu

ps

3.    Use  Figure  4.8  (aka  4.25)  to  answer  the  following  questions.           a.    What  is  Olga’s  unit-­‐labor  requirement  in  apple  production?    Olga  can  produce  10  apples  with  one  day  of  work.    This  is  her  productivity.    The  unit-­‐labor  requirement  is  the  reciprocal  of  labor  productivity  or,  1/10  day  per  apple.    Mathematically,  plug  values  into  the  production  function  and  solve  for  aLA:        QA  =  LA/aLA        10  apples  =  1  day/aLA          aLA    =    1  day/  10  apples    or  1/10  day  per  apple.             b.    What  is  Maria’s  labor  productivity  in  orange  production?    Maria  can  produce  15  oranges  in  a  day.    This  is  her  labor  productivity  in  oranges    Mathematically,  plug  values  into  the  production  function  and  solve  for  1/aLO        QO  =  (1/aLO)LO        15  oranges=  (1/aLO)  *  1  day          (1/aLO)    =      15  oranges  per  day.       c.    How  much  more  productive  is  Olga  in  orange  production  than  Irina?    Olga’s  productivity  in  oranges  is  25  oranges  per  day.    Irina’s  productivity  is  10  oranges  per  day.    Therefore  Olga  is  25/10  =  2.5  times  more  productive  that  Irina  in  oranges.       d.    What  is  Maria’s  apple  productivity  relative  to  Irina’s?    Maria’s  apple  productivity  is  15  apples  per  day.    Irina’s  apply  productivity  is  25  apples  per  day.    Therefore  Maria  is  15/25  =  3/5ths  as  productive  in  apples  as  Irina.       e.    What  is  Irina’s  opportunity  cost  of  apple  production?    The  slope  of  Irina’s  PPF  as  plotted  is  25  apples/10  oranges  which  is  Irina’s  OC  for  oranges.    Her  OC  for  apples  is  the  reciprocal  or  10  oranges  per  25  apples  =  10/25  =  2/5  oranges/apple.                            

 4.  Based  on  the  Edgeworth  box  diagram  for  companies,  Gallo  and  Kraft,  each  working  for  one  month,  answer  these  questions    

      Kraft   Gallo  

A.    Productivity  of  cheese  production  (include  units)   1000  lbs/month   200  lbs/month  

B.    Productivity  of  wine  production  (include  units)   750  gals/month   600  gals/month  

C.  Opportunity  cost  of  cheese  production  (include  units)   0.75  gals/lb   3  gals/lb  

D.    Absolute  Advantage  in  cheese  production  (check  one  box)  

X    

Cheese (lbs)

600

10000

300

Gallo’s PPF

Kraft’s PPF

Win

e (g

als)

200 OG

OK

A B

E

D F

G 600

100 800

600

C

E.    Absolute  Advantage  in  wine  production  (check  one  box)  

X    

F.    Comparative  Advantage  in  cheese  production  (check  one  box)  

X    

G.    Comparative  Advantage  in  wine  production  (check  one  box)  

  X  

 

H.    If  Kraft  produces  at  point  D  and  Gallo  at  point  F  before  specialization  and  trade  occur,  what  is  the  amount  of  wine  and  cheese  they  will  produce  in  total  together?      

700  lbs  of  cheese  and  600  gals  of  wine.  

I.    If  Kraft  and  Gallo  each  specialize  in  their  comparative  advantage  good,  what  is  the  total  amount  of  wine  and  cheese  they  will  both  produce?      

1000  lbs  of  cheese  and  600  gals  of  wine.  

J.  At  which  labeled  point  in  the  diagram  would  Gallo  and  Kraft  most  likely  reach  if  they  specialized  in  their  comparative  advantage  goods  and  traded  to  their  mutual  advantage?    

E  

K. What plausible market terms of trade (in gals/lb) could prevail to induce Kraft to increase its profit by specializing in cheese production?  

0.75  gals/lb    <    ToT      <      3  gals/lb    

Any  single  answer  in  the  range  is  acceptable,    e.g.  2  gals/lb  

     

5.    Consider  the  Edgeworth  box  diagram  with  Gina  and  Ken  each  working  for  one  day  prior  to  specialization.  

  Ken   Gina  A.    Productivity  of  cheese  production  (include  units)   80  lbs/day   100  lbs/day  

B.    Productivity  of  wine  production  (include  units)   120  gals/day   30  gals/day  

C.    Opportunity  cost  of  cheese  production  (include  units)   1.5  gals/lb   3/10  gals/lb  

D.    Absolute  Advantage  in  wine  production  (check  one  box)   X    

E.    Comparative  Advantage  in  cheese  production  (check  one  box)     X  

 

F.    Before  specialization  and  trade,  what  is  the  total  amount  of  wine  and  cheese  that  Ken  and  Gina  produce  per  day?      

100  lbs  of  cheese  and  60  gals  of  wine.  

J.    At  which  labeled  point  in  the  diagram  would  Gina  and  Ken  potentially  reach  if  they  traded  prior  to  specialization?    

C  

E

Cheese (lbs) 100

30

Gina’s PPF

Ken’s PPF Win

e (g

als)

OGina

OKen

A B

D

F

60

60

50

C

80

6.    Suppose  there  are  two  sisters,  Irina  and  Maria  who  can  each  produce  apples  and  oranges  with  different  hourly  productivities.    The  diagram  below  depicts  two  situations;  one  in  which  Maria  has  a  lower  orange  productivity  and  one  with  a  higher  productivity.    

 

A.    What  is  Maria’s  lower  orange  productivity?  Include  units.   15  Or/hr    

B.    What  is  Maria’s  higher  orange  productivity?    Include  units.   30  Or/hr  

C.  Indicate  the  joint  PPF  when  Maria’s  orange  productivity  is  low.  (eg.  ABCF)     ABE      (or  EBA)  

D.  Indicate  the  joint  PPF  when  Maria’s  orange  productivity  is  high.    (eg.  ABCF)     ACF  (or  FCA)  

E.    How  many  apples  and  oranges  would  the  sisters  consume  if  they  produce  their  comparative  advantage  goods  when  Maria’s  productivity  is  lower?          

15  oranges  and  25  apples.  

F. An  increase  in  productivity  should  enable  the  sisters  to  consume  more  apples  AND  more  oranges  afterwards  compared  to  the  outcome  in  part  C.    On  the  joint  PPF  with  the  higher  productivity  for  Maria,  draw  and  label  a  point  G  that  satisfies  this  result.  

Any  point  on  the  segment  AC  with  more  than  15  oranges  but  fewer  

than  30  oranges  

Oranges (#)

App

les (

#)

50

40

30

20

10

0 50 40 30 20 10 0

Irina

Maria

Irina

A

B C

D E F

B. Short Essay Questions One of the skills I want students to learn is how to describe economic principles in a simple way without using graphs, or variables, or equations. Often a brief description of a principle will involve relating the results of a model using words; that is, using the models as a guide for what to say. I will give you several exercises like this on the homeworks and you can expect to see several questions of this type on the exams in the future. 1. Briefly explain what motivates Smith and Jones and how it leads them to specialize in the good in which they have a comparative advantage The motivation is self-interest, making more money, or greed. Smith and Jones discover that by producing the good in which they have a comparative advantage they will be able to raise their own profit. Producing more of that good will raise their revenue by more than it will raise their cost. The assumption that they are both motivated by self-interest, or to raise (or maximize) their own utility, implies that they will specialize in production. 2. Briefly describe the four primary changes that can cause economic growth in an economy. Economic growth can be induced by an increase in the amount of resources used to produce, by a reduction in the unemployment of resources (and thereby an increase in the amount of resources used to produce), an increase in the productivity of the resources used to produce (more output with the same amount of inputs), or a rearrangement of resources on the basis of comparative advantage.

C. Jeopardy Style Short Answer Questions Questions Answers

1. In the pure exchange model, the utility of both traders rises because of trade. Is this an assumption or an implication of the model?

implication

2. In the exchange model with production, each person specializes in his comparative advantage good. Is this an assumption or an implication of the model?

implication

3. In the exchange model with production, there are there are only two goods. Is this assumption more likely to be consequential to the result or inconsequential?

inconsequential

4. In the pure exchange model, the traders are assumed to have perfect information about their preferences. Is this assumption more likely to be consequential to the result or inconsequential?

consequential

5. The exchange model with production assumes that the individuals can only produce two goods. Is this assumption included more because it reflects reality or more because it simplifies the model?

More because it simplifies

6. The exchange model with production assumes that the individuals have different productive capabilities. Is this assumption included more because it reflects reality or more because it simplifies the model?

More because it reflects reality

7. If Maria’s unit-labor requirement is 4 hours per pound of cheese and 8 hours per gallon of wine, while Vincent’s unit-labor requirement is 8 hours per pound of cheese and 6 hours per gallon of wine, who has the absolute advantage in cheese? Why?

Maria because her unit-labor requirement is lower (i.e., 4 < 8 hrs/lb)

8. If Maria’s unit-labor requirement is 4 hours per pound of cheese and 8 hours per gallon of wine, while Vincent’s unit-labor requirement is 8 hours per pound of cheese and 6 hours per gallon of wine, who has the absolute advantage in wine? Why?

Vincent because his unit-labor requirement is lower (i.e., 6 < 8 hrs/gal)

9. If Maria’s unit-labor requirement is 4 hours per pound of cheese and 8 hours per gallon of wine, while Vincent’s unit-labor requirement is 8 hours per pound of cheese and 6 hours per gallon of wine, who has the comparative advantage in cheese? Why?

Maria because her opportunity cost of cheese is lower (i.e., 4/8 = 1/2 < 8/6 = 4/3 gal/lb)

10. If Maria’s unit-labor requirement is 4 hours per pound of cheese and 8 hours per gallon of wine, while Vincent’s unit-labor requirement is 8 hours per pound of cheese and 6 hours per gallon of wine, who has the comparative advantage in wine? Why?

Vincent because his opportunity cost of cheese is lower (i.e., 6/8 = 3/4 < 8/4 = 2 lb/gal)

11. If Charlie’s unit-labor requirement is 4 hours per pound of cheese and 8 hours per gallon of wine, while Mario’s unit-labor requirement is 4 hours per pound of cheese and 12 hours per gallon of wine, who has the absolute advantage in cheese? Why?

Neither, because their unit-labor requirements are equal (i.e., 4 = 4 hrs/lb)

12. If Charlie’s unit-labor requirement is 4 hours per pound of cheese and 8 hours per gallon of wine, while Mario’s unit-labor requirement is 4 hours per pound of cheese and 12 hours per gallon of wine, who has the comparative advantage in cheese? Why?

Mario because his opportunity cost of cheese is lower (i.e., 4/12 = 1/3 < 4/8 = 1/2 gal/lb)

13. Always, Never or Sometimes, if a person has an absolute advantage in a good will she have a comparative advantage in that good?

Sometimes

14. Yes or No, is it possible that one person does NOT have a comparative advantage in any good in a two good economy?

Yes

15. Always, Never or Sometimes, in a two good, two person economy, if one person has a comparative advantage in a good, will the other person have a comparative advantage in the other good?

Always

16. Suppose a person’s opportunity cost of cheese production is 1 gal of wine. If the terms of trade in the market is 2 gal per lb of cheese, should this person produce more or less cheese? Explain.

More cheese because she only must give up one gal of wine in production to acquire 2 gals in

trade. Making more cheese is profitable.

17. If it takes a silversmith (1/6) hour of work to produce a silver fork, what is the worker’s productivity? (include units)

6 forks per hour

18. If a worker’s unit-labor requirement is 2 hours per pound of cheese and 4 hours per gallon of wine, how much wine and cheese can he produce if he splits his 40-hour work week equally between the two products? (include units)

10 lbs of cheese and 5 gals of wine

19. If Tom’s productivity is 20 spoons per day or 60 knives per day and Fred’s productivity is 30 spoons per day or 60 knives per day, who has the comparative advantage in spoons? Why?

Fred because his Opp. Cost of spoons = (1/30)/(1/60) = 2 k/s

< Tom’s OC = (1/20)/(1/60) = 3 k/s

20. If a worker’s productivity is 1000 pins per day or 20 model airplanes per day, plot the 5-day work week PPF.

21. Using the graph in the previous answer, indicate the opportunity cost of airplane production. (include units)

(5000/100) = 50 pins per airplane

22. term used to describe an official document that substantiates a person’s ownership of a car or home.

Title

23. It is often said that possession is this percentage of the law. 9/10ths

24. John Locke said that if someone applies this to natural resources the product becomes her property.

Labor or work

25. Identify two methods that can signal that previously unowned property is now yours.

Build a fence, build a house, work the land, graze cattle, tomahawk rights

Model Airplanes (#)

Pins (#) 5000

100

26. name for a common violation of property rights Theft, fraud, murder, etc

27. this government system is used in a country or state to determine the guilt of those who violate property rights

Judicial or court system

28. Who is the most likely owner of Tom’s baseball cap? Tom

29. Who is the most likely owner of Yellowstone National Park in the US? The US government

30. This type of right protects marketable ideas Intellectual property

31. name for the property right granted for an invention. patent

32. Name given to a second good that a consumer might buy if the first good is not available or is too expensive

Substitute

33. Name given to a second good that a consumer might use at the same time as the first good. Complement

34. Name two substitute goods or services for a magazine

Book, Internet sites Newspaper

Etc.

35. Name two complement goods for a magazine

Coffee Cigarette

Tea, Etc

36. Of increase, decrease or stay the same, this would happen to demand for gasoline today if consumers suddenly expect the price to increase substantially next week.

Increase

37. Of increase, decrease or stay the same, this would happen to demand for big screen TVs today if consumers expect a recession to begin soon.

decrease

38. Of increase, decrease or stay the same, this would happen to demand for shrimp today if the wages of shrimp workers rise.

Stay the same

39. Latin phrase used to indicate that all other variables in the model are assumed to remain at their original values.

Ceteris paribus

40. The demand curve for tea normally plots the quantity demanded at every price of coffee, price of tea, price of milk, or income level?

Price of tea

41. Of shift the curve or move along the curve, this would occur to the demand curve for peanuts if the price of popcorn increases

Shift the curve

42. Of shift the curve or move along the curve, this would occur to the demand curve for popcorn if the price of popcorn increases

Move along the curve