Econ 162B A0 A1 Fall 2011 Kenny Christianson due September 9 ANSWER KEY PROBLEM SET NUMBER ONE 1 a Ben Bernanke is Chair of the Board of Governors of the Federal Reserve System b Bernanke believes that the shocks of the past four years have not fundamentally altered the growth potential of the United States economy Eventually the housing market will stabilize and financial markets have already shown some progress Improvements in household balance sheets will increase consumption spending Businesses will continue to invest in new technologies All of these events will help to improve labor markets until the economy returns to its long run growth path c The near term prospects for the economy are not as strong We are still recovering from the financial crisis of 2008 09 when global markets collapsed More recently the global economy has improved especially in emerging markets The United States has seen a modest cyclical recovery that is now in its ninth quarter Banks have improved their capital positions and credit is easing but small business lending remains tight Overall manufacturing exports business investment and productivity have increased Improvements in household debt loads have led to increases in saving in the economy But despite this progress many problems remain After recent downward revisions U S GDP has not yet reached the level it achieved before the recession Economic growth has not been sufficient to achieve any significant reductions in the unemployment rate Increases in commodity prices have strained household budgets even further d The virtual circle of economic recovery is the idea that after a recession pent up demand among households will eventually increase consumption spending To meet the pent up demand firms increase production and hiring so income in the economy increases so households spend more on consumption and firms spend more on investment e The challenges to long run economic growth include an aging population inadequate primary and secondary education high health care costs and the poor quality of economic policy making in Congress f Bernanke states that policy should be aimed at reducing the long term unemployed which would have both short term and long term effects He states that most of the economic policies that support robust economic growth in the long run are outside the province of the central bank Sustainable fiscal policy is necessary to achieve long run economic growth Over time the ratio of debt to GDP should be stable or declining 2 a Positive since it is a fact that can be tested in the real world as true or false b Normative since it is an opinion c Positive because it is a fact d Normative since it is an opinion e Normative since it is an opinion f Positive since it is a causative statement ECON 162B A0 A1 Fall 2011 Answer key one 2 3 Microeconomics is the study of individual economic decision making Examples include the study of household consumption decisions household labor supply decisions firm decisions about how much to produce and what mix of inputs to employ and the study of individual markets such as gasoline or wheat Macroeconomics on the other hand is the study of the relationships between aggregate economic variables including Gross Domestic Product unemployment inflation the money supply interest rates and exchange rates Macroeconomics also studies different models of how aggregate economic variables are related to each other and how fiscal and monetary policy can affect these variables 4 a going to the movies with your friends to a party to a bar or studying biology or another subject watching television by yourself b buying a slice of pizza buying French fries at MacDonald s spending money on entertainment etc The time spent eating the Big Mac also has opportunity costs c the interest you could have earned on the money invested in the MacDonald s franchise the wage you could have earned elsewhere or opening a Taco Bell instead d foregone wages foregone interest on tuition payments whatever else you would do with your time etc e The public funds and resources devoted to a space station could be used for many other types of public goods or services such as schools hospitals or mass transit 5 Sometimes it is necessary to think outside of the box In trying to solve problems we are often limited by our own thought patterns and inability to think through problems in original ways 1 3 4 2 6 a First it is helpful to construct a table to keep track of the quantity of resources being used in the production of both goods If 0 slammers are produced there are 90 shots of vodka and 90 shots of kahlua available for bammer production Since a bammer requires two shots of kahlua then 90 2 45 bammers can be produced Now suppose you want to produce 5 less bammers For 40 bammers 2 x 40 80 shots of kahlua are required This would leave 90 80 10 shots of kahlua for slammer production Since each slammer requires one shot of kahlua then with 10 shots of kahlua 10 slammers can be produced Continue these calculations for 35 bammers 30 bammers etc You can then derive the table presented below Note that up to 30 bammers 30 slammers kahlua is your constraint It is all used up Since bammers require more kahlua than slammers when more bammers are produced than slammers you run out of kahlua Once you produce more slammers than bammers you then run out of vodka If 0 bammers are produced then 90 shots of vodka are available for slammers from which 90 2 45 slammers can be produced ECON 162B A0 A1 Fall 2011 Answer key one 3 You can then derive the following table a BAMMERS SLAMMERS V B V S V K B K S K 90 90 90 90 82 5 75 67 5 60 52 5 45 0 10 20 30 32 5 35 37 5 40 42 5 45 0 10 20 30 32 5 35 37 5 40 42 5 45 45 40 35 30 25 20 15 10 5 0 90 80 70 60 50 40 30 20 10 0 0 20 40 60 65 70 75 80 85 90 45 60 75 90 90 90 90 90 90 90 45 40 35 30 25 20 15 10 5 0 The production possibilities curve looks like this Bammers 45 30 PPC 30 45 Slammers b Yes the production of 30 bammers and 30 slammers is both feasible and efficient since the point lies on the production possibilities curve 40 bammers and 40 slammers is unattainable infeasible since the point lies outside of the PPC The economy does not have the resources or technology to produce this level of output c When 20 of each are produced the utilization of resources is inefficient since the point lies inside the PPC The economy can produce more of one or both goods without sacrificing the output of the other good d