ECON 201 Spring 2000

Problem Set 1
Due February 10

1. Suppose a manufacturing firm is equipped to produce ratios of calculators. It has two plants,
the East Plant and the West Plant, at which it can produce these goods. Given the labor and
capital available at both plants, it can produce the combinations of the two goods at the two
plants shown below. (15 points)
Output per day, East Plant
Combination Calculators Radios
A 100 0
B 50 25
C 0 50

Output per day, West Plant

a. With calculators on the vertical axis and radios on the horizontal axis, draw the
production possibilities curve for the East Plant.

b. On a separate graph, draw the production possibilities curve for the West Plant.
 c. Which plant has the absolute advantage in producing calculators? Radios? Explain.

East has the absolute advantage in producing calculators because it can produce more calculators
than can the West Plant (i.e., it is more productive in the production of calculators). West has the
absolute advantage in producing radios because it can produce 100 radios while East can only
produce 50.

d. Which plant has the comparative advantage in producing calculators? Radios? Explain.

East has the comparative advantage in producing calculators because its opportunity cost of
producing one calculator (i.e. ½ radio) is lower than that of West (2 radios). Likewise, the
comparative advantage in producing radios is in West Plant because its opportunity cost of
producing one additional radio (1/2 computer) is smaller than that of East (2 computers).

e. Now draw the combined production possibilities curve for the two plants.

Here is a graph showing all the possible combinations (9 in all) of radios and calculators which
can be produced by the firm.

The production possibilities curve is found by drawing a line through the set of points
corresponding to the highest production levels as shown below.
(The 2 lines should meet at the production point of 100 and 100).

f. Suppose the firm decides to produce 100 radios. Where will it produce them? How
many calculators will it be able to produce? Where will it produce the calculators?

It will produce 100 radios at West and 100 calculators at East.

2. Mankiw, chapter 1, problems and applications #3. (6 points)

The opportunity cost of skiing is the actual cost of the skiing itself (lift tickets, rentals of
equipment and the like) as well as the foregone wages that you would have received if you had
worked instead. If your alternative activity was studying in the library, then the cost is the direct
cost as well as the lost benefits of studying (for example, a higher grade on a test, less studying in
the middle of the night, etc.). The important concepts to get from this question are twofold: (1)
cost involves the value of what was given up when a choice is made and (2) that costs can be
monetary or non-monetary.

3. (6 points) All other things unchanged, what happens to the demand curve for video rentals if
there is

a. an increase in the price of movie theater tickets? Demand increases and the demand
curve shifts right.
b. a decrease in family income? Demand falls and the demand curve shifts left
c. an increase in the price of video rentals? The quantity of rentals demanded will fall, but
this is reflected as a movement along the demand curve and not as a shift of the curve.

4. Using a supply and demand graph for each event, show graphically and explain in words the
effect of each event on the price and quantity in that particular market. (12 points)

a. How did the heavy rains (causing massive flooding) in South America in 1997 affect the
market for coffee?
Heavy rains decreased the supply of coffee, thereby shifting supply to the left as fewer beans
were available for sale. This increases the price of coffee and decreases the quantity sold.

b. The Surgeon General decides french fries aren’t bad for your health after all and issues a
report endorsing their use. What happens to the market for french fries?
Demand for fries increases due to a change in preferences. The demand curve shifts right and
both price and quantity rise.

c. A new technique is discovered for manufacturing computers that greatly lowers their
production cost. What happens to the market for computers?
The supply curve shifts to the right as production costs fall. Computer prices fall as more are
sold.

5. Children under the age of 2 are now allowed to fly free on U.S. airlines; they usually sit in
their parents’ laps. Some safety advocates have urged that they be required to be strapped in
infant seats, which would mean their parents would have to purchase tickets for them. Some
economists have argued that such a measure would actually increase infant fatalities. Can
you explain why? Consider that many families with small children would see car travel as an
alternative to airline travel. (6 points)

Many families see car and airplane travel as substitutes. Requiring children to have a seat of their
own effectively raises the price of airline travel for a family with kids. As the price of a
substitute rises, the demand for car travel rises as well. People will switch from taking a plane to
driving to vacation destinations. Since car travel is less safe and results in a greater number of
accidents and fatalities, this will increase infant fatalities despite the fact that safety advocates are
pushing for this measure in order to keep infants safer during travel. This is an example of
unintended consequences of an action.

6. Using the Internet, find information on the United States Council of Economic Advisers.
What does the Council do? Who is the current chair and who are the other members? Write a
short essay describing what you found. (5 points)