Homework 1 Answer Key Notes Correct answers highlighted in green explanation provided when deemed necessary by the instructor Q1 Economics deals primarily with the concept of Scarcity Poverty Money Banking Q2 Sophia is planning her activities for a hot summer day She would like to go to the local swimming pool and see the latest blockbuster movie but because she can only get tickets to the movie for the same time that the pool is open she can only choose one activity This illustrates the basic principle that people face tradeoffs improvements in efficiency sometimes come at the expense of equality rational people think at the margin people respond to incentives Q3 Ellie decides to spend two hours taking a nap rather than attending her classes Her opportunity cost of napping is the value of the knowledge she would have received had she attended class the 24 she could have earned if she had worked at her job for those two hours the value of her nap less the value of attending class nothing since she valued sleep more than attending the class Explanation The opportunity cost of something is what you give up for that something in this case the opportunity cost of napping is given by what you would have done instead of napping As the statement of the problem makes clear if Ellie had not taken a nap she would have gone to class which implies that she ranked going to class during those two hours above working during those two hours Therefore the opportunity cost of napping the value of the knowledge obtained in that class Q4 Sophie has a scholarship that pays for all of her college expenses tuition fees textbooks and other materials room and board The value of the scholarship is 40 000 per year If Sophie were not in college this year she would have taken a job in her hometown paying 30 000 Sophie s opportunity cost of attending college for one year is 0 40 000 30 000 70 000 Explanation Again the opportunity cost of going to college is what you give up to go to college By going to college Sophie gives up the 30 000 she would have made at work Q5 Water is essential to life Diamonds are not although they can be some people s best friends However in most circumstances most people are willing to pay a lot more for a diamond than for a glass of water This is because water prices are held artificially low by governments since water is necessary for life producers of diamonds have a much greater ability to manipulate diamond prices than producers of water have to manipulate water prices the marginal cost of producing an extra diamond far exceeds the marginal cost of producing an extra glass of water the marginal benefit to most people of an extra diamond far exceeds the marginal benefit of an extra glass of water Explanation Note that the question asks why people are willing to pay more for diamonds than for water What someone is willing to pay for a diamond depends upon the benefits that buying that extra diamond gives that person the marginal benefit from that diamond not on government policy cost of producing diamonds or collusion among diamond producers to set prices at a high level These factors may affect the price for which diamonds and water are sold in markets but they do affect my willingness to pay for either Unless you are in the middle of the desert whether you drink one more glass of water or not does not make a big difference in your life which is why you are willing to pay very little for a glass of water in most circumstances An additional diamond on the other hand gives most people a lot of satisfaction which means that they are willing to pay a lot for it Now what would change if everyone had dozens of diamonds at home Would their willingness to pay for them change Q6 Suppose the state of Illinois passes a law that bans smoking in restaurants As a result residents of Wisconsin who do not like breathing second hand smoke begin driving across the border to Illinois to eat at restaurants there Which of the following principles does this best illustrate People respond to incentives Trade can make everyone better off Rational people think at the margin Markets are usually a good way to organize economic activity Q7 The following table contains some production possibilities for an economy for a given month Sweaters 4 6 8 Gloves 300 100 If the production possibilities frontier is bowed outward then could be 100 250 150 200 Explanation You could solve this problem by taking two different approaches The first was graphical you could identify the two given points 4 300 and 8 100 graph them the two blue dots on the graph and connect them with a line For the PPF to be bowed outward the point we are looking for 6 would have to be to the right of above the line You could then draw the 4 possible points and see which one was indeed above the line The answer is 6 250 The second approach was mathematical You could find the equation of the line that goes through the two given points In this case you would be looking to find the slope b and the intercept a of the equation where G denotes gloves and S denotes sweaters 1 Using our two points 4 300 and 8 100 we can first find the slope b We now know that the equation of the line is something like 2 To find the intercept a we need to substitute either of the given points in the equation I will use 4 300 The equation we are searching for is then Using this equation we could see the value of G if S 60 and the PPF were a line The PPF however is not a line and so G must be larger than 200 when S 6 The only alternative is G 250 Q8 The following table contains some production possibilities for an economy for a given month Sweaters 10 12 14 Gloves 400 360 If the production possibilities frontier is a straight then must be Explanation Same as the previous question except that now we are looking for a straight PPF rather than a bowed outward PPF which means that we want a point on the line not above it 330 320 310 340 Q9 Assume that Aruba can switch between producing coolers and producing radios at a constant rate Aruba Labor Hours Needed to Make One Radio Cooler 5 2 Which of the following combinations of coolers and radios could Aruba produce in one 40 hour week 11 coolers and 4 radios 13 coolers and 3 radios 3 coolers and 7 radios 5 coolers and 6 radios Explanation It would take Aruba hours to make the first combination hours to make the second hours to make the third and to make the fourth Q10 Ben bakes bread and Shawna knits sweaters Ben and Shawna