Take Home Exam #1. ECON 500 – Summer 2004. 1. The company you manage has already invested $50,000 in developing a new product, but the development is not quite finished. Suppose it would cost you an additional $40,000 to finish development and make the product. a. At a recent meeting, your salesperson reported that the expected revenues from this new product are $75,000. Should you go ahead and finish development and make the product? Clearly explain. (5 points) b. Suppose instead that your salesperson reported that the expected revenues from this new product are $x. For what values of x should you choose to not finish development of this product? Clearly explain. (5 points)2. Imagine a society that produces military goods (“guns”) and consumer goods (“butter”). The Production Possibilities Frontier for guns and butter is illustrated below. a. In the figure above, identify a point which is impossible for this economy to achieve (label this point “U”). In the figure above, identify a point which can be achieved, but is inefficient (label this point “I”). (4 points) b. Suppose the society has two political parties, the Hawks (that want a strong military, but still some consumer goods) and the Doves (that want a smaller military, and more consumer goods). In the figure above: identify a point that the Hawks might argue in favor of (label this point “H”); identify a point that the Doves might argue in favor of (label this point “D”). (4 points) c. Suppose that an aggressive neighboring country reduces the size of its military. As a result, both Hawks and Doves reduce their desired level of Guns by 50%. Which party would realize a bigger “peace dividend,” measured by the resulting increase in the level of output of butter? Clearly explain. (6 points) Guns Butter3. Between 2002 and 2004 the equilibrium price for avocados increased from $1.63 to $1.87, while the equilibrium quantity decreased by 10,000 units. Clearly explain whether or not this observed change could be a result of: i. a decrease in Demand with no change in Supply. (6 points) ii. a simultaneous increase in Demand and decrease in Supply. (6 points) iii. a simultaneous increase in both Supply and Demand. (6 points)4. Abby and Ryan devote each workday to producing either “hamburgers” or “bicycles.” On any given day Abby can produce either 100 hamburgers or 10 bicycles, while Ryan can produce either 64 hamburgers or 8 bicycles. Suppose that trade can take place between these two individuals. i. Clearly explain which individual has an Absolute Advantage in the production of hamburgers. (3 points) ii. Clearly explain which individual has a Comparative Advantage in the production of hamburgers. (3 points) iii. Graphically illustrate the Production Possibilities Frontier for this “two person economy.” Clearly label each intercept, as well as the slope of this curve at each point. (6 points)iv. When producing 6 bicycles as efficiently as possible, how many hamburgers are these two individuals able to produce? Clearly explain. (4 points) v. Give an example of levels of consumption for each individual that are attainable with specialization and exchange, but unattainable without. Explain. (4 points) 5. Consider a market in which Supply and Demand are respectively given by the inverse functions qqPS2)( = and qqPD320)(−=. i. Determine the functional forms of )( pD and )( pS . (4 points)ii. Determine the equilibrium quantity and equilibrium price in this market. (6 points) iii. Suppose “Supply Changes” so that the new inverse supply function is qqPnewS=)( . Does this correspond to an “Increase in Supply” or a “Decrease in Supply”? Clearly explain. (4 points) iv. Determine the new equilibrium quantity and equilibrium price in this market (after the change in Supply described in part (iii) above). (6 points)v. Are your answers to parts (ii), (iii), and (iv) consistent with our discussion in lecture? Clearly explain. (4 points) 6. Michael and Ann each devote 8 hours per day to two productive activities: stuffing envelopes and chopping firewood. Let E denote the number of envelopes stuffed; let F denote the number of cords of firewood chopped. Suppose that trade can take place between these two individuals. It takes Ann 2 minutes to stuff one envelope and 20 minutes to chop one cord of firewood. Michael is not as good as Ann at stuffing envelopes. He requires 3 minutes to stuff a single envelope. Further, Michael needs 15 minutes per cord of firewood to chop each of his first 24 cords of wood. After chopping 24 cords of firewood Michael is very tired. He needs 30 minutes per cord of firewood to chop each cord of wood beyond his 24th cord. i. Determine Ann’s Opportunity Cost for the 1st unit of F that she produces. Clearly explain. (2 points) ii. Determine Ann’s Opportunity Cost for the 12th unit of F that she produces. Clearly explain. (2 points)iii. Determine Michael’s Opportunity Cost for the 1st unit of F that he produces. Clearly explain. (2 points) iv. Determine Michael’s Opportunity Cost for the 26th unit of F that he produces. Clearly explain. (2 points) v. Graphically illustrate the Production Possibilities Frontier for this “two person economy.” Clearly label each intercept, as well as the slope of this curve at each point. (6