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U of M ECON 1101 - Principles of Microeconomics

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Part (a)Part(b)Part(c)Part (d)Part (e)Part (f)Part (g) & (f)Part (i)Part (j)Principles of MicroeconomicsECON 1101 - Fall 2010Department of EconomicsUniversity of MinnesotaPractice Problem on the Benefits of TradeLectures:Website:Office:Hours:Email:Tel:Fax:Problem 1. Consider an economy with two locations, Minnesota and Illinois. The locations canmake two goods ”Sugar Beets” and ”Soybeans”. Minnesota and Illinois can produce the goods asfollows:Soybeans Sugar BeetsMinnesota 8 hours/unit 5 hours/unitIllinois 2 hours/units 4 hours/unit(a) Fill in the following table, computing the opportunity cost of production for each good ateach location. (Note the opportunity cost of one more soybean is in terms foregone sugarbeets. The opportunity cost of one more sugar beet is in terms of foregone soybeans.)Soybeans Sugar BeetsMinnesotaIllinois(b) Who has the absolute advantage in the production of soybeans? Why?(c) Who has the comparative advantage in the production of soybeans? Why?2 Practice Problem on the Benefits of Trade(d) Consider the price of soybeans in terms of sugar beets. What is the highest price at whichsoybeans can be traded that would make both states better off? What is the lowest price?Explain.(e) Graph the production possibilities frontier for Illinois, assuming it has 40 hours. Put soy-beans on the y-axis.(f) Suppose Illinois uses 20 hours to produce soybeans and 20 hours to produce sugar beets.Clearly label the resulting bundle (call it Bundle A) produced on your PPF in part (e).Specifically how many soybeans and how many sugar beets are in Bundle A?Department of Economics University of Minnesota Minneapolis, MN 55454Principles of Microeconomics (ECON1101) 3As you answer the next few parts think about the following definitions• Attainable - Any combination of goods which is inside or on the Production Possib-lities Frontier (PPF).• Unattainable - Any combination of goods which is outside the Production PossiblitiesFrontier (PPF). So with the resources that are give it is a combination of goods whichcannot be produced.• Efficient - Any combination of goods which is ON the Production Possiblities Frontier(PPF).• Inefficient - Any combination of goods which is not ON the Production PossiblitiesFrontier (PPF).(g) On the diagram in part (e) label a bundle that has the same amount of sugar beets as BundleA that is attainable AND inefficient. Call this Bundle B.(h) On the diagram in part (e) label a bundle that has the same amount of sugar beets as BundleA but is unattainable. Call this Bundle C.(i) If Illinois and Minnesota were to specialize in production and then trade, what good shouldIllinois specialize in and why?(j) Suppose the price of one soybean is 1 sugar beet. Starting at Bundle A, Illinois specializesin the good you chose in part (i). It produces one more unit of this specialized good andtrades with Minnesota. The new bundle consumed is Bundle D. How many sugar beets andhow many soybeans are in Bundle D? Plot Bundle D on diagram in part (e).Department of Economics University of Minnesota Minneapolis, MN 554544 Practice Problem on the Benefits of TradeSolution.Part (a)Soybeans Sugar BeetsMinnesota85sugar beetsIllinois12sugar beets 2 soybeansPart(b)Illinois has the absolute advantage in production of soybeans since they requires fewer resources(time) to produce soybeans than Minnesota.Part(c)Illinois has the comparative advantage in the production of soybeans since they have a lower op-portunity cost of production than Minnesota.Part (d)• High price:85sugar beets. If the price were any higher Minnesota would produce soybeansitself; Minnesota would not trade.• Low price:12sugar beets. If the price were lower Illinois would not cover its opportunitycost; Illinois would not trade.Department of Economics University of Minnesota Minneapolis, MN 554545/8 soybeansPrinciples of Microeconomics (ECON1101) 5Part (e)Part (f)Bundle A consist of 5 sugar beats,204= 5, and 10 soybeans,202= 10Part (g) & (f)See the diagram in part (e).Part (i)Illinois should specialize in the production of soybeans since it has the comparative advantage.Part (j)Bundle D consist of 5.5 sugar beats and 10 soybeans.In order of Illinois to produce on more soybean they need to take 2 hours away from the productionof sugar beets which would decrease the production of sugar beets by .5 units. Thus, the after tradeproduction would for Illinois would be a movement along the their PPF to 4.5 sugar beets and 11soybeans.Now Illinois will trade the extra soybean they just produced to Minnesota in exchange for a sugarbeet. Thus, Illinois will consume 5.5 sugar beets and 10 soybeans. Department of Economics University of Minnesota Minneapolis, MN


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U of M ECON 1101 - Principles of Microeconomics

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