Practice Questions 1-

I. True/False and explain:

1. An economy with a linear PPF displays increasing opportunity cost.

2. "Income inequality is bad for our economy" is a normative statement.

3. Suppose firm MM has a linear PPF, it can produce 600 monitors or 300 televisions in a single day.  The equation for the firm's weekly (where a week is 5 work days)  PPF is y=3,000-2x where y is the symbol for monitors and x is the symbol for televisions.

4. According to the law of demand, when the price of Pepsi rises, the quantity demanded of Pepsi will necessarily fall.

5. Scarcity causes the negative slope of the PPF and specialization within a country causes its PPF to be bowed outward.

6. A price floor always leads to a surplus in the market.

7. Opportunity cost equals the quantity of goods you must give up divided by the quantity of goods you will get.

8. The opportunity cost of an additional unit of the good on the vertical axis is the number of units of x that must be given up which numerically equals the absolute value of one over the slope of  the PPF.

9. Scarcity affects only people who live in poverty.

10. Sara has a comparative advantage in producing honey if she can produce more honey than Bob can.

11. The more resources that are devoted to technological research and capital stock at the expense of current consumption, the faster the PPF shifts outward.

12. A nation can produce at a point outside its PPF when it trades with other nations.

13. A nation can consume at a point outside its PPF when it trades with other nations.

14. Whenever a person can produce less of all goods than anyone else can, that person has a comparative advantage in something.

15. A supply curve shows the maximum price required in order to have the last unit of output produced.

16. If the expected future price of a good rises, its current price rises.

17. In the real world, what we observe are price increases primarily, therefore our demand for goods is always decreasing.

18. The law of increasing opportunity cost tells us that the opportunity costs of our choices tend to rise over time.

19. The United States is an example of a pure market economy in which all resource allocation is accomplished through the market.

20. A recession can be illustrated by a movement downward and rightward along a country's production possibilities frontier.

II. Short Answer Problems:

1. Australia and New Zealand can produce either steel or coal. The maximum production for each good and the time periods for that production are given in the table.

Assume that a country produces a constant amount of any good per unit of time, and assume that opportunity costs for both of these countries are constant.

                         Australia                      New Zealand

 Steel (ton)        20 per year                   1/3 per month

Coal (tons)       5/6 per month               4/3 per two month period

a. Which country has an absolute advantage in the production of steel and coal respectively?

b. Which country has a comparative advantage in the production of steel and coal respectively?

c. What will be the pattern of specialization if these two countries trade? And who will benefit from the trade?

d. Draw the PPF of the production of steel and coal in Australia and New Zealand with steel on the y-axis.

e. If the technology of producing coal in New Zealand developed such that it can produce 12 tons per year, go through problem 1 to 4 again.

2. Suppose the demand and supply for bananas in the US are:

Qd = 10 - Pd

Qs = 2Ps -2

a. Draw the Supply (S) and Demand (D) and find the equilibrium price and quantity.

b. Suppose that the government decides to impose a tax of $1.50 per banana on bananas. Will this tax result in a shift in or a movement along the supply curve? Will this tax result in a shift in or a movement along the demand curve? What is the new equilibrium price with the tax?

c. Calculate the change in consumer surplus, producer surplus and the dead-weight loss. Show the corresponding areas in the diagram you draw.

d. Suppose now the government wishes to restrict the quantity of bananas traded to 4 units.  How big an excise tax should be imposed to reach this goal?

3. Suppose the market for radios is described by the demand and supply functions:

Qd = 50 - 2Pd

Qs = 11 + PS

a. Draw a diagram and find out the equilibrium price and quantity.

b. Suppose the government sets a price ceiling of $11. What will be the effect of such a policy: a shortage or a surplus of how much?

c. Now with the invention of the CD players, the demand for radios is cut to half as much at all prices, what is the new equilibrium price and quantity?  What is the effect on the price ceiling?