Download FreeResponseAnswers

AP ECONOMICS---Ippolito
a) September 2009
FREE RESPONSE: ANSWER KEY Unit #1
Each question is worth 20 points each. 80 points total
1) The following questions refer to the Production Possibilities Frontier
a) Draw a separate PPF graph for each of the following countries
i) A constant cost PPF curve for a country that produces Houses & Food
ii) An increasing cost PPF curve for a country that produces Houses & Food
b) Clearly explain what the slope of an PPF curve/line illustrates and the primary reason for the different shape of a constant
cost PPF curve versus an increasing cost PPF
c)
State 2 changes which would allow a country to move beyond its PPF line in the long run
d) Briefly explain the effect of a sudden drop in GDP (speed of circular flow) on the PPF of a country
ANSWERS:
a)
b) Slope measures the opportunity cost of producing one good in terms of the other good. A constant cost (straight line)
PPF assumes all resources, including workers, are perfectly substitutable. So if 1 house = 5 food then it is always a
ratio of 1 to 5. Whereas, an increasing cost (bowed out) assumes workers who produce houses are not all equally
efficient at making cars. As you move workers from one area to the next, you lose efficiency with each additional
unit produced. => Hence the opportunity cost of houses in terms of food rises as you move along the PPF line. It
may be 1 to 5 to start and then move to 1 to 10 and then to 1 to 20 etc….
c) Rise in Technology or increase in population
d) It would not effect the PPF line (no shift). The line is not necessarily where a society is producing, it is the full
potential of a society (full efficiency). It assumes full employment of all resources. (including labor) You are at
your full potential when on the line, if you were in a recession you would be below the PPF
Grade Scale:
20 points Each
A: 18-20
B: 16-17
C: 14-15
D: 12-13
F: 11 & below
A: 72-80
B: 64-71
C: 56-63
D: 48-55
F: 47 & below
2) The market for Cell Phones is in equilibrium at: Price = $150 and Qty = 1,000,000
a) Clearly Explain the reasons a demand curve is downward sloping
b) Draw a properly labeled graph of the initial market equilibrium for Cell Phones as listed above.
c) Modify the graph for any change if the government decided to raise taxes on cell phone manufacturers. (Make sure you label
all new points!)
d) State the change on the following: (use proper terminology when appropriate!)
i) Equilibrium price & quantity
ii) Supply
iii) Demand
==================================================================================
==================================================================================
Answers:
a) A demand curve is downward sloping because of the substitution effect and the law of diminishing marginal
utility. As you consume more of a product, each unit becomes less valuable to you (less utility). Therefore,
consumers will only demand a higher quantity only as price falls to match their falling utility. Also, because you can
purchase other “substitute” good => as the price of one good falls relative to another, new buyers enter the market
B + C)
Cell Phones
S2 S
1
Price
P2
---------- E2
-------------- E1
-----------------------------
150
Q2 1 million
D1
Qty
d) State change on
i)
ii)
iii)
Price ↑ & Qty ↓
Decrease in Supply
Decrease in quantity demanded (or change in quantity demanded)
3) Assume that two countries, Brazil and Russia, have equal amounts of resources.
Brazil
Russia
Cars
40
20
Tractors
10
60
a) State which country has
i) a comparative advantage in Cars.
ii) a comparative advantage in Tractors
iii) an absolute advantage in Cars
iv) an absolute advantage in Tractors
b) State the terms of trade which will make each country better off trading Cars  Tractors (i.e. cars for tractors)
c) Clearly Explain why, in economic theory, trading using your terms of trade will make each country better off than
before the country engaged in trade.
ANSWERS:
Cars
40
Cars
BRAZIL
RUSSIA
20
10
60 Tractors
Tractors
Opportunity Cost Table
BRAZIL
MEXICO
1/4 Tractor
1 Car = ____
1 Tractor =
4
____
Car
3 Tractors
1 Car = _____
1 Tractor =
1/3 Car
____
a) State which country has
i) Brazil
ii) Russia
iii) Brazil
iv) Russia
b) State the terms of trade which will make each country better off trading Cars  Tractors (i.e. cars for tractors)
1/3 < X < 4 Cars per Tractor OR 1/4 < X < 3 Tractors for Cars
c) In theory, each country should produce a good where they have a comparative advantage. This means they
produce a good where they have a lower opportunity cost than their partner. If you trade within the term of trade, then
each country will be better off. (to the right of their PPF)
For example, Russia can currently produce 1 tractor for every 1/3rd of a car on their own. If they make only tractors and
trade for cars at a ratio of more than 1/3rd car per tractor they improve their production potential. For example if they
now get 2/3rd cars per tractor then end up above their own PPF graph.
Brazil can currently produce 4 cars for every tractor on their own.
If they make only cars and trade for cars at a ratio of less than 4 cars per tractor they improve their production potential.
For example if they now only have to give 3 cars per tractor then end up above their own PPF graph.
4) The market for Bottled Water is at equilibrium.
Price = $150 and Qty = 10 million bottles
a) Draw a fully labeled Supply & Demand Graph for the market for Bottled Water based on the information above.
b) Modify your existing graph that accounts for any changes based on the following new information:
A Scientific Study concludes drinking tap water is very unhealthy compared to bottled water and the Government imposes new
expensive regulations on the manufacturing of bottled water.
c)
Briefly explain the reasons for any change or lack of change in the following:
i) Demand for Bottled Water
ii) Supply of Bottled Water
d) State the effect on equilibrium price.
i) Justify your answer
e) State the effect on equilibrium quantity.
i) Justify your answer
ANSWERS:
a + b)
Bottled Water
S2
Price
P1
---------------------------
P2 --------------- E2
S1
-------------- E1
Q1,
D1
D2
Qty
Q2
C) Briefly Explain
i) Determinant of demand changed, Tastes increased, => Demand shifts right
ii) Determinant of supply changed, Tax or Input prices rose => Supply shifts left
d) Equilibrium price rises
i) Since D increases leads to price ↑
& Supply decrease leads to Px ↑ , price must increase
e) Equilibrium quantity is indeterminate
a. D increase leads to Qty ↑ while Supply decrease leads to Qty ↓, so quantity is indeterminate
Why: because you do not know the magnitude of either S or D shift you cannot determine the
effect on quantity.