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Question 2. American and Japanese workers can each produce four cars a year. An American
worker can produce 10 tons of grain a year, whereas a Japanese worker can produce 5 tons of
grain a year. To keep things simple, assume that each country has 100 million workers.
Question 2a
Panel (a.1) shows the production opportunities available to America and Japan
Production Opportunities
Question 2b
Panel a2 shows the combination of cars and grains that America can produce
Panel a3 shows the combination of cars and grains that Japan can produce
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Both production possibilities frontiers are derived assuming that America and Japan each utilize
100 million workers. If there is no trade, each person’s production possibilities frontier is also his
or her consumption possibilities frontier.
Question 2 c
Opportunity Cost
1 Car 1 ton Grain
The table above shows that for America the opportunity cost for producing 1 car is 2 ½ ton of
grain, while Japan’s opportunity cost for the same car is 1 ¼ tons of grain.
Inversely, America’s opportunity cost for producing 1 ton of grain is 2/5 of a car while Japan is
4/5.
Question 2 d
Absolute Advantage
Since both countries has the same output per worker for the production of cars, neither country
has an absolute advantage in producing cars.
However, America has an absolute advantage in producing grain, since it produces more grain per
worker
Question 2 e
The table shows that for America the opportunity cost for producing 1 car is 2 ½ tons of grain,
while Japan’s opportunity cost for the same car is 1 ¼ tons of grain. The opportunity cost for
producing cars is less for Japan. Therefore, Japan has the comparative advantage in producing
cars.
Inversely, America’s opportunity cost for producing 1 ton of grain is 2/5 of a car while Japan is
4/5. America has the lower opportunity cost of producing grain. Therefore, America has the
comparative advantage in producing grain
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Question 2 f
Without trade, (see fig a2 point A above) America will produce 200million cars and 500millions
tons of grain.
Japan will produce the equal amount of cars as America (see fig a3 point B above), however, they
will only produce 250 million tons of grain.
Question 2 g
Trade can benefit everyone in society because it allows people to specialize in activities in which
they have a comparative advantage. The proposed trade between America and Japan offers each
of them a combination of cars and grain that would not have been possible without trade.
In panel 1 below, America gets to consume at A 1 rather than at point A. Giving an increase
in consumption of +20 million cars and +100 million tons of grain. See table 2 below
At point C Americas still produced both cars and grain, however prominence were given to
the production of grain because they had comparative advantage over cars
In panel 2 below, Japan gets to consume at B 1 rather than at point B. Given an increase in
consumption of +20 million cars and +50 million tons of grain. See table 2 below
At point C Japan opted to specialize in the production of cars, since they have comparative
advantage in this area
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2. Market Forces of Supply & Demand: Chap. 4, pg 85, ques. 1, 3 & 13.
Question 1
Explain each of the following statements using supply-and-demand diagrams.
“When a cold snap hits Florida, the price of orange juice rises in supermarkets throughout the
country.”
Due to the cold snap many oranges fields was destroyed
This reduced the quantity of oranges produced there by reducing the supply of oranges
At the same price, there will be fewer oranges, which will shift the supply curve inward at S2
Figure 1 shows, this decrease in supply from S1 to S2. This shift will also raises the equilibrium
price and the equilibrium quantity falls
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“When the weather turns warm in New England every summer, the price of hotel rooms in
Caribbean resorts plummets.”
Due to the warm, weather in England the demand for hotels in the Caribbean decreases shifting
the demand curve to the left (see fig below) from D1 to D2
The equilibrium price and equilibrium quantity will decrease
The shift in demand curve causes the equilibrium price at P1 to reduce to P2, in addition
The equilibrium quantity will also be reduced from Q1 to Q2
c. “When a war breaks out in the Middle East, the price of gasoline rises, and the price of a used
Cadillac falls.”
Due to the war, the production of oil will be affected, reducing the supply of gasoline.
The reduction in gasoline will shift the supply curve to the left from S1 to S2
This left shift in supply causes the equilibrium price and equilibrium quantity to increase
This increase results in higher price of gasoline from P1 to P2
The quantity of gasoline being sold will also be reduced from Q1 to Q2
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Its general knowledge that old vehicles consumes more gasoline: therefore, observing that the
price of gasoline has increased.
The demand for used Cadillacs will shift from D1 to D2
The left shift the demand curve will causes the equilibrium price and equilibrium quantity to
decrease
Due to the reduction demand for Cadillac’s the price of same will fall from P1 to P2
Note, gasoline and vehicles are called complements because a change in the price of gasoline
will affect the demand for vehicles.
Question 3
3. Consider the market for minivans. For each of the events listed here, identify which of the
determinants of demand or supply are affected. Also, indicate whether demand or supply increases
or decreases. Then draw a diagram to show the effect on the price and quantity of minivans.
Therefore, this will shift the demand curve to the right from D1 to D2 which indicates an
increase in demand and ultimately may increase prices
.
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Question 13
The supply schedule of tickets is reflected on the supply curve with a vertical line. A vertical
supply curve is indicative of perfectly inelastic supply curve. Simply put, the same quantity of
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tickets is available at all price points, it does not matter how much patrons are willing to pay. For
example, there is a demand for 10,000 tickets at the price of $4, but only 8,000. No additional
tickets can be generated. Inversely, at the price of $20, there is still 8,000 tickets available.
Therefore, a change in the price has no effect on the quantity supplied
Question 2
a, For business travelers, the price elasticity of demand when the price of tickets rises from $200
to $250: Formula
(1900−2000)÷[(1900+2000)÷2] −0.051
= (200−250)÷[(200+250)÷2]
= = 0.229
0.222
For vacationers, the price elasticity of demand when the price of tickets rises from $200 to $250=
(600−800)÷[(600+800)÷2] −0.285
(250−200)÷[(250+200)÷2]
= = 1.283
0.222
b, Answer: the price elasticity of demand for vacationers is higher than the elasticity for business
travelers because vacationers can opt for different mode of transportation or substitutes for
traveling. For example, they may decide to use transit flights or use trains or even drive because
speed of travel is not a priority. For most business travelers speed may be paramount because of
their schedules.
Question 9
a, Use these data to estimate the price elasticity of demand for subway rides.
P1 = 1.25; P2 = 1.50
(4.3 ÷100)
Price elasticity of demand=
(1.50−1.25)÷[(1.50+1.25)÷2]
= 0.2365
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b, According to your estimate, what happens to the Transit Authority’s revenue when the fare
rises? Answer: The price elasticity of demand is lower than 1 (0.2365) this suggest that subway
rides are inelastic. Therefore, an increase in price will increase profit significantly.
There are a number of variables that are not considered when calculating elasticity. In this example
other factor that may influence demand may include but not limited to;
Travelers income
Increase or decrease demand for subway traveling
Uncontrollable variables like the weather condition or crises influencing demand
The transaction of a new fridge will contribute to the consumption component of GDP
Consumption is expenditure on goods and services by the households. Goods include both the
durable and non durable goods. Eg of durable goods are fridges and non durable goods are food
and clothing services are those which are physically visible but can be felt such as intangible items
such as the medical care and education.
Buying a new house contributes to the investment component of GDP Investment is spending
money on a purchase of capital equipment, inventories and structures. Other factors that can
influence GDP in home purchase include, broker fees, closing cost, home inspection, appraisal,
construction cost etc. In addition, if it were a newly constructed home then the gain retained on
the sale of the house would be included in GDP.
Changes the consumption and investment components of the GDP However as the change in
transaction of money is exactly equal and opposite for both of these GDP components there will
not be any change in GDP in fact when ford produces the car and instead of selling it complements
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it to its inventory ford is supposed to have purchased the car for personal use. That is the car is
treated as part of fords investment spending. However when ford sells the car out of the inventory
ford’s inventory investment is negative counterbalancing the positive expenditure of the buyer.
Same as fridge.
This has an impact on both the consumption and net exports components of the GDP. Buying
French wine by my parents is consumption expenditure, however French wine has to be imported.
There for an import of French wine decreases the net exports component of the GDP.
A purchas of French wine increases consumption component and decreases the net export
component of the GDP
This increases investment and thus increases GDP Investment is the process of investing on
purchase of goods that are used for the manufacturing of more goods and services in the future. It
is an investment for the future. Purchase of capital equipment, inventories and structures together
gives us the total investment. Therefor the factory built in Ohio is investment expenditure, and
causes an increase in GDP.
Question 4
a. Compute nominal GDP, real GDP, and the GDP deflator for each year, using 2010 as the base
year:
Nominal GDP
2010: ($1/qt milk x 100) + ($2/qt honey x 50) = $200
2011: ($1/qt milk x 200) + ($2/qt honey x 100) = $400
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b, Compute the percentage change in nominal GDP, real GDP, and the GDP deflator in 2011 and
2012 from the preceding year. For each year, identify the variable that does not change
real GDP is Zero. Additionally prices for milk and honey did not change from 2010 to 2011, that’s
Although prices rose 2012, there were no change in real GDP. However, there was a rise in real
Question 8
a, Each person’s value-added (VA) equals the value of what he/she produced minus the value of
the intermediate inputs he/she started with.
Farmer’s VA = $100
Miller’s VA = $50
Baker’s VA = $30
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GDP = $180
Note that GDP = value of final good = sum of value-added at all stages of production.
b, Value added is defined as the value of a producer’s output minus the value of the intermediate
goods that the producer buys to make the output. Assuming there are no intermediate goods beyond
those described above, calculate the value added of each of the three producers.
Farmer’s VA = $100
Miller’s VA = $50
Baker’s VA = $30
Question 11