Economics 101Summer 2011Answers to Homework #2Due Tuesday, May 31, 2011Homework is due at the beginning of the lecture. All homework should be neatly and professionally done.Please make sure that your name is clearly legible and that you show all of your work on your homework.Please staple your homework before coming to class.1. Joe and Mary both produce gadgets and widgets. Mary can produce 100 gadgets and 0 widgets, or 0 gadgets and 50 widgets or any combination of gadgets and widgets that lie on the straight line between these two points. Joe can produce 400 gadgets and 0 widgets, or 200 gadgets and 50 widgets or any combination of gadgets and widgets that lie on the straight line between these two points. Currently Joe and Mary are not trading with one another; Joe is producing 200 gadgets and 50 widgets while Mary is producing 50 gadgets and 25 widgets. a. Draw Joe’s production possibility frontier for gadgets and widgets on a graph where gadgets are measured on the y-axis and widgets are measured on the x-axis. Then write an equation for Joe’s PPF where G is gadgets and W is widgets. b. Draw Mary’s production possibility frontier for gadgets and widgets on a graph where gadgets are measured on the y-axis and widgets are measured on the x-axis. Then write an equation for Mary’s PPF where G is gadgets and W is widgets. c. Who has the absolute advantage in the production of widgets?d. Who has the absolute advantage in the production of gadgets?e. Who has the comparative advantage in the production of widgets?f. Who has the comparative advantage in the production of gadgets?g. If Mary and Joe specialize and trade with one another, what would their combined PPF look like? Drawa graph of this combined PPF where gadgets are measured on the y-axis and widgets are measured on the x-axis. Describe verbally how this combined PPF differs from the individual PPFs you drew in parts (a) and (b). h. What is a range of trading prices in gadgets that 10 widgets would trade for?i. What is a range of trading prices in widgets that 5 gadgets would trade for?Answer:a. G = 400 – 4Wb. 1G = 100 – 2Wc. Joe has the absolute advantage in the production of widgets.d. Joe has the absolute advantage in the production of gadgets. e. Mary has the comparative advantage in the production of widgets since her opportunity cost of producing one widget is 2 gadgets while Joe’s opportunity cost of producing one widget is 4 gadgets. f. Joe has the comparative advantage in the production of gadgets since his opportunity cost of producing one gadget is ¼ widget while Mary’s opportunity cost of producing one gadget is ½ widget. g. The combined PPF is bowed out away from the origin due to specialization according to comparative advantage. 2h. One widget would trade between 2 gadgets and 4 gadgets, so 10 widgets would trade between 20 gadgets and 40 gadgets. i. One gadget would trade between ¼ widget and ½ widget, so 5 gadgets would trade between 5/4 widgetsand 5/2 widgets. 2. For each of the following scenarios sketch a diagram representing the scenario and then answer the given questions.a. The market for bicycles in Madtown is initially in equilibrium. Then, the city government passes legislation that increases the costs of driving a car in Madtown. Holding everything else constant, what doyou think will happen to the price of bicycles and the quantity of bicycles in Madtown?b. The market for bicycles in Madtown is initially in equilibrium. Then, the price of aluminum, an important input in the production of bicycles, increases. Holding everything else constant, what do you think will happen to the price of bicycles and the quantity of bicycles in Madtown?c. The market for bicycles in Madtown is initially in equilibrium. Then, the city government passes legislation that increases the costs of driving a car in Madtown. At the same time the price of aluminum, an important input in the production of bicycles, increases. Holding everything else constant, what do youthink will happen to the price of bicycles and the quantity of bicycles in Madtown?d. The market for cookies in Chipville is initially in equilibrium. Then, people’s income in Chipville increases. Holding everything else constant, what do you think will happen to the price of cookies and thequantity of cookies in Chipville? Fully explain your answer. e. The market for ice cream cones in Dairyland is initially in equilibrium. Suppose that ice cream cones are a normal good and that the price of apple pie, a substitute good for ice cream cones, increases. Holding everything else constant, what do you think will happen to the price of ice cream cones and the quantity of ice cream cones in Dairyland?f. The market for ice cream cones in Dairyland is initially in equilibrium. Suppose that ice cream cones are a normal good and that the price of apple pie, a substitute good for ice cream cones, increases. At the same time suppose that the price of milk used in the production of ice cream cones decreases. Holding everything else constant, what do you think will happen to the price of ice cream cones and the quantity of ice cream cones in Dairyland?Answers:a. When the price of driving in Madtown increases this causes a rightward shift in the demand for bicycles since driving is a substitute good for bicycling. In the market for bicycles this demand shift will cause the both the price of bicycles and the quantity of bicycles to increase.b. When the price of aluminum increases this causes the supply curve for bicycles to shift to the left. Holding everything else constant, this leftward shift in the supply curve will cause the price of bicycles to rise while the quantity of bicycles decreases relative to their initial levels. 3c. There are two events happening in this scenario. The demand curve for bicycles shifts to the right (see the answer to (a)) and the supply curve for bicycles shifts to the left. Since both curves are shifting simultaneously and since we do not know the relative size of these shifts, we can conclude that either the price or the quantity will be indeterminate in this market. In this case, we know that the equilibrium price will increase relative to its initial level and the equilibrium quantity may increase, decrease or remain the same relative to its initial level. d. A change in income will cause the demand curve to shift: however, we do not know the direction of the shift since we are not told if cookies are a normal or an
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