Download Answer to Quiz #2

Economics 102
Summer 2011
Answers to Quiz #2
June 27, 2011
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1. True or False: “Provided that their opportunity costs of production are not equal, two countries will
find that specialization of production and trade according to comparative advantage will increase the
overall level of production.”
a. True
b. False
Use the following information to answer the next two questions.
Each time Country A decides to produce 1 bicycle it must give up 2 radios. Each time Country B decides
to produce 1 radio it must give up 3 bicycles.
2. If the two countries specialize according to their comparative advantage Country B should produce
a. Radios
b. Bicycles
3. If the two countries specialize according to their comparative advantage then 10 radios will trade for
a. Between 5 and 30 bicycles.
b. Between 3.3 and 20 bicycles.
4. Consider the market for oil. It was initially in equilibrium and then two events occurred. Unrest in the
Middle East disrupted the supply of oil. At the same time several countries decided to release some of
their oil reserves to the market. Relative to the initial equilibrium in the market, the combination of these
two events will
a. Result in a lower price and greater quantity in the market relative to the initial equilibrium.
b. Results in a lower price and lower quantity in the market relative to the initial equilibrium.
c. Results in a lower price and an indeterminate change in quantity in the market relative to the initial
equilibrium.
d. Results in an indeterminate change in price and an indeterminate change in quantity in the market
relative to the initial equilibrium.
5. Which of the following statements is true? Circle all answers that you agree are true.
I. When a small country opens a market to trade and the world price is greater than the equilibrium
domestic price then the country will export the good.
II. When a small country opens a market to trade, the trade results in positive economic gains.
III. When a small country opens a market to trade, domestic consumers have a greater consumer surplus
than they had when the market was closed to trade.
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Word Problem:
Suppose the market for a good in a small closed economy is described by the following demand and
supply equations:
Domestic Demand: P = 100 – 2Q
Domestic Supply: P = 20 + 2Q
a. If this economy is closed, what is the equilibrium price and quantity?
Answer:
100 – 2Q = 20 + 2Q
80 = 4Q
Q = 20
P = 60
b. What is the value of consumer surplus and producer surplus if this is a closed economy?
Answer:
CS = (1/2)(40)(20) = $400
PS = (1/2)(40)(20) = $400
c. Suppose this economy opens to trade and the world price of this good is $80. Describe what happens in
this market when this economy opens to trade. In your answer identify 1) whether this country imports or
exports the good; 2) the numeric level of imports or exports; 3) who benefits from this economy opening
to trade; and 4) what happens to consumer surplus and producer surplus (provide a numeric value).
Answer:
1) The economy will export the good since the world price of the good is greater than the domestic
price of the good when the market is closed to trade.
2) The small economy will export 20 units of the good.
3) Domestic producers benefit from this decision since they now sell more units of the good at a
higher price.
4) Consumer surplus with trade equals $100 and producer surplus with trade equals $900.
d. CHALLENGE QUESTION: Suppose this economy opens to trade and the world price of this good is
less than the equilibrium price of the good when the economy is closed to trade. Domestic producers
lobby the government to enact a tariff on this good. Suppose this tariff results in a producer surplus of
$225. What is the tariff price for this good?
Answer:
PS = (1/2)bh = (1/2)(Pt – 20)(Qt) where Pt is the price with the tariff and Qt is the quantity with the tariff
You know PS = 225 so
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225 = (1/2)(Pt – 20)(Qt)
450 = (Pt – 20)(Qt)
Now, you need to find another way of expressing Qt
P = 20 + 2Q from the supply curve or
2Q = P – 20
Q = (.5)P – 10
Thus, 450 = (Pt – 20)[(.5)Pt – 10]
450 = .5Pt2 – 20Pt + 200
0 = .5Pt2 – 20Pt – 250
0 = Pt2 – 40Pt – 500
0 = (Pt – 50)(Pt + 10)
Or Pt = 50 (the other root for this equation Pt = -10 is a nonsensical answer for this application)
Check: if Pt = 50 then Q = 15 (use the supply curve to get this quantity)
PS = (1/2)(30)(15) = $225
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