Homework 1-

1. Are the following statements true or false?  Explain.

(a) The opportunity cost of an action is measured by the monetary cost incurred in order to do the action.

(b) Opportunity cost does not have to be measured in a monetary unit (such as dollars). 

(c) Mercel lives in a big house in Switzerland that he owns.  Since he does not have to pay rent, his opportunity cost for living in this house is zero.

2. The following two graphs represent production possibility frontiers for countries A and B.  Both of these countries produce milk (measured in gallons) and pork (measured in pounds). 

(a) Explain what a production possibility frontier represents.

(b) What is country A's opportunity cost of producing one gallon of milk in terms of pork?  What is country A's opportunity cost of producing one pound of pork in terms of milk?

(c) Is country B's opportunity cost of producing one gallon of milk higher at point E than at point F?  Explain.

(d) Which country has an absolute advantage in producing milk?  Which country has an absolute advantage in producing pork?

(e) Based on the information given, can we say which country has a comparative advantage in producing milk?  Explain.

3. Bill and Bob work for UW.  They are in charge of cleaning classrooms and of advising students about registration.  In a day, Bill can clean 20 classrooms and advise 0 students or he can advise 50 students and clean 0 classrooms. Bill can also do any other combination of these two activities that sits on his linear production possibility frontier.  In the same amount of time, Bob can clean 16 classrooms and advise 0 students or he can advise 20 students and clean 0 classrooms. Bob can also do any other combination of these two activities that sit on his linear production possibility frontier.  Answer the following questions based on this information.

(a) Who has the absolute advantage in cleaning classrooms?  Who has the absolute advantage in advising students?

(b) Who has a comparative advantage in cleaning classrooms?  Who has a comparative advantage in advising students?

(c) Assume that Bill and Bob are not friends and do their work separately.  Also assume that they each split their time equally on the two tasks.  How many classrooms are cleaned each day?  How many students are advised each day?

(d) Now assume Bill and Bob decide to work together.  Is there any way to improve their joint performance?  Explain.

(e) Who gains from the cooperation you described above?  Who loses?

(f) Based on what you learned in this exercise, comment on the following claim:

Since China's technology is improving rapidly and China's labor cost is still low, the US will soon have no comparative advantage in any industry.  So gains from trade are going to vanish. 

4. Are the following statements true or false?  Explain your answer.

(a) If a price of a good is higher than the equilibrium price, there will be an excess demand.

(b) If the supply curve remains unchanged while the demand curve shifts, the equilibrium price and quantity will move in opposite directions (e.g. if price increases, then quantity decreases).

(c) At equilibrium, all consumers who want to buy the good at the equilibrium price can buy the good.

(d) At the equilibrium price, the quantity demanded and the quantity supplied are the same.

5. Assume that coffee and milk are complements.  Assume that coffee beans are needed to make coffee.  Also assume that:

i. A new technology allows producers to produce milk at a lower cost.

ii. There is going to be a poor harvest of coffee this year because insects destroyed the crop of coffee beans.

The goal of this exercise is to find what will happen to the equilibrium price and quantity in the coffee market (the unit of the quantity in this market is a cup).  Answer the following questions by drawing graphs.

(a) How will the change (i) affect the equilibrium price of milk?

(b) How will the change in the price of milk affect the market for coffee?

(c) How will the change (ii) affect the market for coffee?

(d) What will happen to the equilibrium price and quantity in the coffee market?