1. Suppose there are two countries, Capriland and Melodia. Both countries produce two goods, pianos and cars. Furthermore, assume that both countries have linear production possibility frontiers (PPFs). The following table provides information about the amount of labor necessary to produce one piano or one car in each of these two countries. Assume that Capriland and Melodia both have a total of 120 hours of labor available to devote to the production of pianos and cars. (Hint: put pianos (P) on the vertical axis and cars (C) on the horizontal axis as your work the various parts of this problem.)

Labor Needed to Produce One Piano Labor Needed to Produce One Car
Capriland 2 hours of labor 10 hours of labor
Melodia 4 hours of labor 12 hours of labor

a. (2 points) Given the above information, write an equation that represents Capriland’s PPF. In your equation pianos should be abbreviated as P and cars should be abbreviated as C.
With 120 hours of labor Capriland can produce 60 pianos and 0 cars or 12 cars and 0 pianos. Using these two points we can write an equation for Capriland’s PPF as P = 60 – 5C. This equation could also be expressed as C = 12 – (1/5)P.
b. (2 points) Suppose that the amount of labor available for the production of pianos and cars is now 60 hours. You are told that Melodia is currently producing on its PPF and Melodia is producing 3 cars. Calculate how many pianos Melodia is making.

Melodia’s PPF can be written as P = 15 – 3C if Melodia has 60 hours of labor. If C is equal to 3 then this implies that P is equal to 6. That is, P = 15 – 3(3) = 15 – 9 = 6. Melodia is producing 6 pianos.

c. (4 points) Given the initial information about Capriland and Melodia, determine whether each of the following statements is true or false.
i. The opportunity cost of producing one more car for Melodia is greater than the opportunity cost of producing one more car for Capriland. ______False_________
ii.The opportunity cost of producing one more piano for Capriland is greater than the opportunity cost of producing one more piano for Melodia. ______False________

d. (3 points) Given the initial information about Capriland and Melodia, suppose these two countries decide to specialize and trade with one another. Find the acceptable range of prices in terms of cars that 10 pianos will trade for. Show your work. Make sure your answer is clearly labeled.

The opportunity cost of producing one car for Capriland is 5 pianos while the opportunity cost of producing one car for Melodia is 3 pianos. Thus, one car will trade for between 3 pianos and 5 pianos. Or, one piano will trade for between 1/5 car and 1/3 car. Ten pianos will therefore trade within the range of 2 cars to 10/3 cars. Or, between 2 cars and 3.3 cars.

e. (2 points) Given the initial information, which country has the comparative advantage in the production of cars?

Melodia has the comparative advantage in the production of cars since the opportunity cost of producing one car for Melodia is 3 pianos while the opportunity cost of producing one car for Capriland is 5 pianos.

f. (2 points) Given the initial information, which country has the absolute advantage in the production of pianos?

With 120 hours of labor, Capriland can produce 60 pianos while Melodia can produce 30 pianos: Capriland has the absolute advantage in the production of pianos.

g. (5 points) Given the initial information, construct a PPF that illustrates the combined production possibility frontier for these two countries. If the PPF has different linear segments identify the coordinates of the endpoints for any segment. Label your graph carefully and completely. Measure pianos (P) on the vertical axis and cars (C) on the horizontal axis.

2. Suppose you are given the following information about the demand and supply in a market. Assume that both the demand and supply curves are linear.

Price Quantity Demanded Quantity Supplied
0 200 ----
20 160 ----
40 120 0
60 80 200
80 40 400
100 0 600

a. (2 points) Write the equation for the market demand curve given the above information. In your equation represent price as P and the quantity demanded as Qd. Write your equation in slope intercept form.

P = 100 – (1/2)Qd

b. (2 points) Write the equation for the market supply curve given the above information. In your equation represent price as P and the quantity supplied as Qs. Write your equation in slope intercept form.

P = 40 + (1/10)Qs

c. (4 points) Given the above information, find the equilibrium price (Pe) and the equilibrium quantity (Qe) for this market.

100 – (1/2)Qe = 40 + (1/10)Qe
60 = (6/10)Qe
Qe = 600/6
Qe = 100 units
Pe = 100 – (1/2)Qe
Pe = 100 – (1/2)(100)
Pe = \$50 per unit
Or, Pe = 40 + (1/10)Qe
Pe = 40 + (1/10)(100)
Pe = \$50 per unit

d. (2 points) When the market is in equilibrium, what is the value of consumer expenditure on this good?

Consumer expenditure is equal to the price per unit times the number of units. Or, consumer expenditure is equal to (\$50 per unit)(100 units) = \$5,000.

e. (2 points) When this market is in equilibrium, what is the value of consumer surplus?

The value of consumer surplus is equal to (1/2)(\$100 per unit - \$50 per unit)(100 units) = (1/2)(\$50 per unit)(100 units) = \$2500

f. (2 points) When this market is in equilibrium what is the value of producer surplus?

The value of producer surplus is equal to (1/2)((\$50 per unit - \$40 per unit)(100 units) = (1/2)(\$10 per unit)(100 units) = \$500

g. (3 points) Suppose the government sets a price floor equal to \$70 in this market. Describe the effect of this price floor on the market. Be sure to comment on and quantify any surplus or shortage that occurs as a result of this price floor. In addition, be sure to comment on whether the price floor is effective or not.

This price floor is effective since it has been set at a level that is greater than the equilibrium price in the market. The price floor will result in a situation of excess supply. At a price floor of \$70, 60 units will be demanded and 300 units will be supplied: there will be excess supply of 240 units.

h. (3 points) Suppose the government sets a price ceiling equal to \$30 in this market. Describe the effect of this price ceiling on the market. Be sure to comment on and quantify any surplus or short that occurs as a result of this price ceiling. In addition, be sure to comment on whether the price ceiling is effective or not.

The price ceiling is effective since it has been set at a level that is less than the equilibrium price in the market. The price ceiling will result in a situation of excess demand. At a price ceiling of \$30, 140 units will be demanded and 0 units will be supplied: there will be an excess demand of 140 units.

3. Answer the next question based on the following information.
Suppose there are two consumers, Yi and Saad, in a market. Yi’s demand curve is given by the equation Q = 50 – 2P while Saad’s demand curve is given by the equation P = 100 – Q.

a. (6 points) In the space below draw a graph that represents Yi’s demand curve and a separate graph that represents Saad’s demand curve. Label these two graphs clearly and completely.

b. (6 points) In the space below draw a graph that represents the market demand curve. Label this graph clearly and completely. Make sure you identify the y-intercept and the x-intercept. If the demand curve has different linear segments, make sure you identify the coordinates of the endpoints of each segment.

c. (4 points) Find the market demand curve and write it in slope intercept form. If there is more than one demand curve equation, identify the relevant range of prices that is applicable for each demand curve equation.

For prices greater than or equal to \$25, the market demand curve is just Saad’s demand curve, P = 100- Q. For prices less than or equal to \$25, the market demand curve is P = 50 – (1/3)Q.

d. (4 points) Suppose the market supply curve is given as Qs = 12P. Given this information and your previous work, how many units will Saad buy of the good and what price per unit will he pay?

Rewrite the supply curve as P = (1/12)Qs and then use this equation and the relevant demand equation to solve the problem for the equilibrium quantity and price. When price is \$25, Qs is equal to 300: this indicates that the supply curve will cross the lower portion of the demand curve. Thus, the market demand curve is P = 50 – (1/3)Q and the market supply curve is P = (1/12)Q. Using these two equations we find that Qe = 120 and the equilibrium price is \$10 per unit. We know that Saad will pay \$10 per unit, but then how many units will he demand at that price? Use Saad’s demand curve to find this out: P = 100 – Q and P = \$10 per unit. Thus, Qd for Saad is 90 units.

Multiple Choice Questions (20 questions worth 2 points each)

1. Suppose two economists are debating macroeconomic policy. One economist argues for the implementation of a policy to reduce the overall unemployment rate while the other economist argues the merits of a policy directed at stabilizing the overall price level. This disagreement reflects
a. Positive differences between the two economists’ viewpoints.
b. Normative differences between the two economists’ viewpoints.

2. “Sustained increases in the money supply lead to inflation.” This statement is a
a. Positive statement.
b. Normative statement.

3. A recent study reports that binge drinking by females on college campuses over the past twenty years has increased dramatically. This report most likely utilizes
a. Cross-section data.
b. Time series data.

4. You are given two points on a straight line: (X, Y) = (10, 10) and (-10, -20). You are told this line shifts to the right by 20 units (i.e., the shift is a parallel shift and at any given price consumers now demand 20 more units than they did initially). The equation for the new line is
a. Y = 3/2X - 5
b. Y = 3/2X + 5
c. Y = 2/3X – 35
d. Y = 3/2X – 35

Use the following information to answer the next 3 (three) questions.

Consider an economy that produces only two types of goods: consumer goods and capital goods. In the table below you are given five points that lie on this economy’s production possibility frontier (PPF). Assume that this PPF is linear between each of the given points: that is, the PPF is linear between points A and B, linear between points B and C, linear between points C and D, etc.

Combination Consumer Goods Capital Goods
A 700 0
B 600 250
C 400 550
D 200 700
E 0 800

5. Based on the above information, which of the following statements is true?
a. Since the PPF is composed of linear segments the Law of Increasing Opportunity Cost is not true in this example.
b. The Law of Increasing Opportunity Cost is true for the production of consumer goods but not for the production of capital goods.
c. The Law of Increasing Opportunity Cost is true for the production of capital goods but not for the production of consumer goods.
d. The Law of Increasing Opportunity Cost is illustrated in this example when we consider the entire PPF.

6. Suppose this economy is currently producing at point C. The opportunity cost of producing one more unit of consumer goods is equal to
a. .75 units of capital goods.
b. 1.5 units of capital goods.
c. 300 units of capital goods.
d. 150 units of capital goods.

7. Suppose this economy is currently producing on its PPF. If the economy’s current capital good production is equal to 325 units then its consumer good production is equal to
a. 500 units
b. 450 units
c. 575 units
d. 550 units

8. Consider the market for wheat that is initially in equilibrium. Suppose that there is bad weather in areas of the world that grow wheat while simultaneously people’s incomes increase. Assume wheat is a normal good. From this information we know
a. The equilibrium price and equilibrium quantity in the wheat market will increase.
b. The equilibrium price will increase while the equilibrium quantity will decrease in the wheat market.
c. The equilibrium price will increase while the equilibrium quantity may increase, decrease or remain the same in the wheat market.
d. The equilibrium quantity will increase while the equilibrium price may increase, decrease or remain the same in the wheat market.

9. Consider the market for gasoline that is initially in equilibrium. Suppose that there is unrest in the Middle East, a major supplier of oil products, and this unrest disrupts the production of oil products. Simultaneously suppose that both India and China report significant increases in the number of cars sold in their economies. These two effects, holding everything else constant, will
a. Definitely cause the equilibrium price of gasoline to increase.
b. Definitely cause the equilibrium quantity of gasoline to decrease.
c. Result in an increased demand for electric cars.
d. Answers (a), (b), and (c) are all correct.
e. Answers (a) and (c) are both correct.

10. Suppose the government implements minimum wage legislation in the labor market and this results in the wage rate in the market not equaling the equilibrium wage rate. Then it must be the case that this minimum wage legislation
a. Involves implementing a maximum wage that can be paid where this maximum wage is less than the equilibrium wage rate.
b. Involves the government mandating a minimum wage in excess of the equilibrium wage rate.
c. Provides jobs for all low-skilled workers at the minimum wage level.
d. Answers (a) and (c) are both correct.
e. Answers (b) and (c) are both correct.

11. New York City’s rent control policies are an example of
a. A price floor.
b. A price ceiling.

12. Which of the following statements is true?
a. Effective minimum wage legislation benefits all low-skilled workers in the economy.
b. An effective price floor represents the maximum price that can be charged in that market.
c. An effective price ceiling creates inefficiency since it prevents some mutually beneficial transactions from occurring.
d. Answers (a), (b) and (c) are all correct.
e. Answers (b) and (c) are both correct.

Use the following information to answer the next 3 (three) questions.

Consider an agricultural market where the market demand and market supply for the product are given by the following equations:
Market Demand: P = 500 – 5Q
Market Supply: P = 100 + 3Q
P is the price per unit of the product and Q is the quantity of the product.

13. If there is no government intervention in this market and the market reaches equilibrium then
a. The equilibrium price is \$250 and the equilibrium quantity is 50 units.
b. Total surplus in this market is equal to \$10,000.
c. Total expenditure on this good is equal to \$12,500.
d. Answers (a), (b) and (c) are all correct.
e. Answers (a) and (b) are both correct.

14. Suppose the government implements a price floor in this market. Which of the following statements is true?
I. To be effective the price floor must be set at a price greater than \$50.
II. To be effective the price floor must be set at a price greater than \$250.
III. An effective price floor will create a surplus of the product.
a. Statements I and III are both true.
b. Statements II and III are both true.
c. Statement II is true.
d. Statement III is true.
e. Statement I is true.

15. Suppose the government implements a guaranteed price program where the government sets the guaranteed price at \$310. The government tells producers to produce the quantity they wish to produce given this guaranteed price and then to sell the good at whatever price they can. The government will then pay the producers the difference between the guaranteed price and the price consumers are willing to pay. Which of the following statements is true given this information?
a. The government’s subsidy per unit of product is equal to \$160.
b. Consumer expenditure on the product equals \$17,500.
c. There is no storage cost to the government with this program.
d. Answers (a), (b) and (c) are all correct.
e. Answers (a) and (c) are both correct.

16. Suppose the price of cheeseburgers decreases. If cheeseburgers and French fries are complementary goods then which of the following statements is true?
a. In the market for French fries demand will shift to the right.
b. When the price of cheeseburgers increases this causes the demand curve for cheeseburgers to shift to the right.
c. In the market for French fries there will be a movement along the supply curve.
d. Answers (a), (b) and (c) are all correct.
e. Answers (a) and (c) are both correct.

17. Joe purchases pistachios and walnuts. This year Joe’s income has fallen by 25% due to the recession and his purchases of pistachios fell by 10% while his purchases of walnuts fell by 35%. Holding everything else constant, we can conclude from this information that for Joe
a. Walnuts are an inferior good while pistachios are a normal good.
b. Pistachios are an inferior good and walnuts are a normal good.
c. Walnuts and pistachios are both inferior goods.
d. Walnuts and pistachios are both normal goods.

18. Consider the market for beach umbrella rentals per day in a small resort community. In the off-season the market demand and the market supply for beach umbrella rentals per day are given by the following equations:
Market Demand: P = 100 – Q
Market Supply: P = Q
During the peak season the quantity demanded at every price increases by 50 units per day while the quantity supplied at every price increases by 20 units per day. Which of the following statements is true given this information?
a. The peak season equilibrium price is \$15 greater than the off season price.
b. The peak season equilibrium quantity of rentals per day is the same as the off season equilibrium quantity of rentals per day.
c. Peak season daily revenues from the rental of beach umbrellas are twice the level of off season daily revenues from the rental of beach umbrellas.
d. Answers (a), (b) and (c) are all correct.
e. Answers (a) and (c) are both correct.

19. Mary reads in the newspaper that incomes in China are rising and that world production of wheat is smaller this year due to bad weather. Holding everything else constant and based on this information, if wheat is a normal good which of the following statements is true?
a. The equilibrium price of wheat will increase while the equilibrium quantity of wheat will decrease.
b. The equilibrium price of wheat will increase and the equilibrium quantity of wheat will increase.
c. The equilibrium price of wheat will decrease and the equilibrium quantity of wheat will decrease.
d. The equilibrium price of wheat will decrease while the equilibrium quantity of wheat will increase.
e. None of the above answers are correct given the information.

20. A campus organization, Investors of the Future, announces their kick-off meeting for the fall semester and in its advertisement it stresses that there will be free pizza and soda at the meeting.
a. Joe should definitely go to this since the pizza and soda will be free.
b. The pizza and soda although they have a zero dollar price are not free since Joe can only get the free pizza and soda by giving up another activity that he could be doing instead of attending the kick-off meeting.  