Homework 2-

1. Econoland and Free Enterprise are two economies each producing two goods: airplanes (A) and grains (G). Currently the two economies do not trade with one another. The table below provides information about the amount of labor needed to produce one airplane or one ton of grains for each economy. Assume that labor is the only input needed to produce either airplanes or grains.

For this question assume that both economies have linear production possibility frontiers (PPF). Furthermore, assume that both countries have 3000 hours of labor available for the production of airplanes and grains.

a. In two separate graphs draw the PPFs for these two economies. In each graph measure airplanes on the horizontal axis and grains on the vertical axis. Make sure you label each graph clearly as to whose PPF is represented in the graph. Also label the numerical values of the x and y intercepts in each graph.

b. Write an equation in slope intercept form for Econoland's PPF and an equation in slope intercept form for Free Enterprise's PPF.

c. What is Econoland's opportunity cost of producing one additional airplane?

d. What is Free Enterprise's opportunity cost of producing one additional ton of grain?

e. What is Econoland's opportunity cost of producing ten additional tons of grain?

f. What is Free Enterprise's opportunity cost of producing four additional airplanes?

Suppose these countries decide to specialize and trade with one another.

g. What good should Econoland produce? Explain your answer.

h. What good should Free Enterprise produce if the two economies specialize? Explain your answer.

i. Provide a range of trading prices in terms of tons of grain acceptable to both countries if 10 airplanes are traded.

j. Provide a range of trading prices in terms of airplanes acceptable to both countries if 25 tons of grain are traded. (Note: these numbers will be messy.)

k. Draw a graph of the joint PPF of these two economies. Measure airplanes on the horizontal axis and grains on the vertical axis. Provide numerical values for any intercepts as well as any "kinks" in your PPF.

l. Write the equations for each segment of the PPF you drew in (k). Make sure you identify the relevant range for each equation you write.

2. Econoland and Free Enterprise, the two economies from the first problem are still our focus. Nothing has changed with these two economies except that Econoland has trained their labor force and now finds that it takes only 50 hours of labor to produce one airplane. Given this information you are asked to answer this next set of questions.

a. Who has the comparative advantage in producing airplanes now?

b. Who has the comparative advantage in producing tons of grain now?

c. Provide a range of trading prices in terms of tons of grain acceptable to both countries if 10 airplanes are traded.

d. Provide a range of trading prices in terms of airplanes acceptable to both countries if 25 tons of grain are traded.

e. Draw the new joint PPF of these two economies. Measure airplanes on the horizontal axis and grains on the vertical axis. Provide numerical values for any intercepts as well as any "kinks" in your PPF.

f. Write the equations for each segment of the PPF you drew in (k). Make sure you identify the relevant range for each equation you write.

3. Draw a diagram for each of the following scenarios and then make a verbal statement about the effect of the described changes on the market. In your description make sure you discuss shifts and the direction of these shifts, movements, changes in the equilibrium price, and changes in the equilibrium quantity.

a. The market for bicycles is initially in equilibrium. Suppose that the Madison Transit Authority imposes a mandatory usage fee to all bicyclists in Madison.

b. Consider the market for petroleum which is initially in equilibrium. Civil unrest erupts in the Middle East, a major production region for petroleum.

c. Consider the level of aggregate production in an economy. The economy is initially in equilibrium and then, due to a financial bubble, the demand for goods and services in this economy decreases at every price level. At the same time government reacts to consumer pressure to reduce government spending on goods and services.

d. Consider the market for brownies which is initially in equilibrium. Suppose that the price of chocolate, a major ingredient in brownies, increases while simultaneously the price of milk, a complementary good to brownies, decreases.

4. Consider the small closed economy of Smithville. Smithville produces birdhouses and the domestic demand and domestic supply curves for birdhouses in Smithville are given below.

Domestic Demand for birdhouses: Q = 10 - P

Domestic Supply for birdhouses: Q = P - 2

The world price of birdhouses is $4.

a. Calculate the value of consumer surplus (CS), producer surplus (PS), and total surplus (TS) in the market for birdhouses if Smithville is a closed economy.

b. Calculate the value of consumer surplus (CSopen), producer surplus (PSopen), and total surplus (TSopen) in the market for birdhouses if Smithville is an open economy.

c. If Smithville is an open economy how many birdhouses will Smithville export or import?

d. Suppose Smithville opens its economy to trade but imposes a tariff of $1 per birdhouse. How many birdhouses will Smithville import or export given this scenario?

e. Calculate the value of consumer surplus with the tariff (CStariff), producer surplus with the tariff (PStariff), tariff revenue for the government, and deadweight loss due to the tariff (DWLtariff).

f. Relative to open trade, will this tariff be politically supported by consumers in Smithville? Explain your answer.

g. Is opening the market for birdhouses to trade in Smithville a good policy move? Discuss your answer.

5. Consider the small closed economy of Smithville. Smithville produces birdhouses and the domestic demand and domestic supply curves for birdhouses in Smithville are given below.

Domestic Demand for birdhouses: Q = 10 - P

Domestic Supply for birdhouses: Q = P - 2

The world price of birdhouses is $4. Officials in Smithville have decided to open the birdhouse market to trade while imposing an import quota of 3 units. (Here a unit of birdhouses might be a box of hundreds of birdhouses...don't worry if you get a fraction of a unit as your answer!)

a. What will be the price of birdhouses in Smithville with this import quota?

b. What will be the total quantity of birdhouses demanded in Smithville with this import quota?

c. How many birdhouses will domestic producers in Smithville provide to this market?

d. What is the deadweight loss due to this import quota?

e. If the government officials in Smithville wanted to implement a quota that had the same impact on consumer and producer surplus as a tariff of $1, how big would the import quota need to be? (Hint: if you think about this logically you will not need to do any math-provided you answered question #4 in its entirety!)

6. Suppose that the market for widgets is described by the following demand and supply curves:

Demand: P = 20 - 2Qd

Supply: P = 2Qs

a. What is the equilibrium price and quantity given this information?

Suppose the government decides to limit the production of widgets in this economy by imposing a quantity control of 2 units.

b. How much will it cost producers to purchase a permit allowing them to produce the good?

c. Given the quantity control, what will the value of consumer surplus be?

d. Given the quantity control, what will the value of producer surplus be?

e. Given the quantity control, what will be the government revenue from issuing and selling permits to produce widgets?

f. Given the quantity control, what will the deadweight loss from this program be?

g. Does the sum of government revenue from the quantity control + producer surplus from the uantity control + consumer surplus from the quantity control + deadweight loss from the quantity control equal total surplus prior to the imposition of this program by the government?