Principles of Economics

Problem Set #1
Due: Wed., September 10
1.

Professor Pete Ferderer

Fall 2014

Classify each of the following statements as positive or normative.

a)
b)
c)
d)
e)

The death penalty does not deter people from committing murder.
The City of St. Paul should require all companies to pay a living wage.
Obesity leads to health problems so governments ought to restrict soda sales.
Cigarette taxes raise the price of cigarettes and reduce their demand.
Global warming will cause the polar bear to become extinct.

2.

Suppose I give you a free ticket to see Lady Gaga in concert tonight. Coldplay is also playing a
concert tonight and it is the only other activity you are considering. The Coldplay ticket costs $40 and
you would be willing to pay up to $60 for it. How much must you value seeing Lady Gaga in order for
you to attend her concert? Explain.

3.

Suppose the table below shows the points you expect to earn given the number of hours spent studying
for tests in each subject. For example, if you study physics for one hour you will earn 40 points on the
physics test. If you spend two hours studying physics you will earn 65 total points in physics, etc.
Assume your only goal is to maximize the total points and you do not care which subjects they are
earned in.
Hours
0
1
2
3
4
5
6
7

Physics
0
40
65
80
90
95
99
100

Points Earned
Basket Weaving
70
80
90
95
100
100
100
100

Economics
0
30
46
60
72
80
86
90

a)

Suppose you have only one hour to study and can apply it to only one subject. How would you
utilize it to maximize the points earned? What was the marginal benefit you obtain? What was
the opportunity cost?
b) Suppose you have a second hour. How would you allocate it? What was the benefit of allocating
the second hour the way you did? What was the opportunity cost?
c) Suppose you have five hours. How many hours would you use to study for each subject if your
goal was to maximize the total points scored? What is the maximum achievable?
d) List the five principles of economics that are at work in this problem.
4.

An economy consists of three workers: Larry, Moe, and Curly. Each works 10 hours a day and can
produce two services: mowing lawns and washing cars. In an hour, Larry can either mow one lawn or
wash one car; Moe can either mow one lawn or wash two cars; and Curly can either mow two lawns or
wash one car.
a)

Calculate how much of each service is produced under the following circumstances, which we
label A, B, C, D:
-

All three spend all their time mowing lawns. (A)

All three spend all their time washing cars. (B)
All three spend half their time on each activity. (C)
Larry spends half his time on each activity, while Moe only washes cars and Curly only mows

lawns. (D)
b) Graph the production possibilities frontier for this economy. Using your answers to part (a),
identify points A, B, C, and D on your graph.
c) Explain why the production possibilities frontier has the shape it does.
d) Are any of the allocations calculated in part (a) inefficient? Explain.
5.

In an hour, Jack can carry 4 buckets of water up the hill or bake 1 pie, and Jill can carry 6 buckets of
water up the hill or bake 2 pies. Explain in one or two sentences
a)
b)
c)
d)

6.

Who has an absolute advantage in carrying water up the hill?

Who has an absolute advantage in pie baking?
Who has a comparative advantage in carrying water up the hill?
Who has a comparative advantage in pie baking?

The following table describes the production possibilities of two states:

Minnesota
Wisconsin

Loafs of Bread per

worker per hour
4
2

Pounds of Cheese per

worker per hour
2
4

a)

Without trade, what is the price of bread (in terms of cheese) in Minnesota? What is the price in
Wisconsin?
b) Draw the production possibilities frontier (PPF) for each state assuming each has 100 hours of
labor available. How much bread and cheese will be produced and consumed in each state if they
are at the PPF mid-point? Label these points as A.
c) Which state has a comparative advantage in the production of bread? Which has a comparative
advantage in the production of cheese? Explain.
d) Assume that each state specializes in the production of the good in which it has a comparative
advantage and trades with the other state. Also, people desire to consume equal quantities of
bread and cheese (one loaf of bread for each pound of cheese). How much of each good does
each state produce, consume, import and export?
e) In your original PPF diagrams, illustrate the points of production by B and consumption by C.
f) By how much will specialization and trade increase consumption of each good in each state
compared to the case in which they did not trade (part b)? That is, what are the gains from trade?
g) What is the price of bread (in terms of cheese) at which trade will occur?
7.

Suppose the production possibilities for the two states in problem 6 change to:

Minnesota
Wisconsin
a)

Loafs of Bread per

worker per hour
5
1

Pounds of Cheese per

worker per hour
1
5

How much of each good is consumed in each state when they do not trade? Assume they consume
at the PPF mid-point.
b) How much of each good is each state consuming if they specialize and trade? Assume they wish
to consume equal quantities of bread and cheese (one loaf of bread for each pound of cheese) after
trade.
c) By how much will specialization and trade increase consumption of each good in each state
compared to the case in which they did not trade (part a)? That is, what are the gains from trade?
d) Compare to what we saw in problem 6, what does this problem teach us about the relationship
between opportunity cost and the gains from trade?