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Akos Lada
[email protected]
Harvard Kennedy School
Summer Program 2014
Problem Set #1
(Due Friday, July 25th)
Supply and Demand
1. The following is based on the assigned article: Whatever Happened to the Food Crisis, The Economist, July
4, 2009.
The following statements have been extracted for you to analyze their impact on the supply and demand of
world food prices - specifically agricultural crop prices. For each statement, determine the impact on price
and quantity (ceteris paribus) for the crop indicated. Then in the language of an economist communicate
what is happening to supply and demand (i.e., was it a change in supply and/or demand and/or a change in
quantity of supply and/or demand).
a) (Do this problem in regards to the general market for cereal crops) "The European Union shelved a
programme that had obliged farmers to leave 10% of their land fallow"
b) (Do this problem in regards to the general market for soybeans) "Take oil prices, for example: oil (and
government subsidies) determines how much maize is planted for ethanol. That in turn influences how
much land is planted to soybeans, which for many farmers around the world are interchangeable with
maize." (Excerpt has been edited)
Extra information: Maize (corn) is used for ethanol, soybeans are not. Assume oil prices are increasing
over the time period being discussed.
c) (Do this problem in regards to the general market for cereal crops) "At the moment, the world’s
population is 6.7 billion and 750m people are born each year. Though the rate of increase is declining,
inertia means the total will go on rising until 2050, when the population will reach 9 billion. In Ethiopia,
for example, 18m children are born every year, rising to 24m a year by 2040. That will double its
headcount from 80m to 160m."
PPF
2. In this problem we will be examining the United States' and China's hypothetical production possibility
curves (ie. production possibility frontiers). Instead of placing narrow types of goods on the two axes, we
will be placing very broadly defined goods on the axes. These good categories will be "consumer goods"
and "capital goods" (capital goods are plants/facilities, equipment, technology, etc. - in other words, capital
goods are goods that help us make other goods - when countries produce capital goods economist
sometimes refer to these production decisions as capital investments). Assume all goods made in either
country can be classified as one of these two types of goods.
a) Draw a single graph with capital goods and consumer goods on the two axes. Place both the United
States' and China's PPF on this graph. To help you do this, here is some information:
The United States Nominal GDP: $14.264 trillion
The United States GDP (PPP): $14.264 trillion
China's Nominal GDP: $4.33 trillion (in dollar denominated terms)
Akos Lada
[email protected]
Harvard Kennedy School
Summer Program 2014
China's GDP (PPP): $7.8 trillion
Note: These GDP numbers are given simply to give you an idea of each country's production capacity.
You don't have to be exact by any means.
Use the PPP GDP numbers as your reference when constructing the PPFs. They are more reflective of
the true production capacity of the two countries.
A little information about purchasing power parity (this is not required material - read at your
leisure):
Purchasing power parity: a theory of exchange rates whereby a unit of any given currency should be able to
buy the same quantity of goods in all countries.
Explanation: Assume $1 can purchase a 12 oz. can of coke. Also assume $1 can be exchanged for 8.2
Yuan (the Chinese currency). Then it would be assumed a 12 oz. can of coke cost 8.2 Yuan. However, this
is often not the case. Instead, it may only cost 3.9 Yuan to purchase a 12 oz. can of coke. Therefore, a
United States citizen would truly get more for his money when he goes to China. Thus, in this example, we
want to use the PPP numbers to determine the size of each countries' PPF.
Note: For more, see page 707.
b) The PPFs for the two countries should have bowed-out shapes. What does the changing slope of each
country’s PPF mean in economic terms?
Note: You are NOT expected to do outside research for this question in regards to China and United States.
The following questions should just represent your current knowledge. The goal of these questions is to get
deeper understanding of the PPF model, not to know all about the US's and China's production realities.
c) Assuming countries who invest in capital goods at a higher rate than consumer goods grow at a faster
rate, place a dot on each country's PPF which reflects the amount of capital and consumer goods each
country has chosen to produce. Assume that each country is producing efficiently - it's a big stretch, I
know. Next to each dot write US09 and China09.
d) Based on your answer in (c), what percentage of each country's production capacity has gone to
producing capital goods (just estimate)? What percentage of each country's production capacity has gone
to producing consumer goods (just estimate)? In absolute terms, which country is producing more
capital goods?
e) Name 3 public policies that may expand a country's PPF over time. (To answer this, think about what
expands a county's PPF - not what they need to do to be on their PPF, but how do they actually expand it
outward.)
f) Wherever you placed your dot on the US's PPF, we would assume if you aggregated all of the capital
goods produced in the US and all of the consumer goods produced in the US, the market value of those
goods would be $14.246 trillion. Knowing what you know about the PPF, if the United States decided
to switch all their production capacity to the production of consumer goods, would the total market
value of those consumer goods equal $14.246 trillion? Explain why or why not.
Akos Lada
[email protected]
Harvard Kennedy School
Summer Program 2014
Trade
Note: All numbers in this question are fictitious.
3. Germany and Vietnam are considering entering into a trade agreement regarding textile goods and
automobiles. Currently, Germany has the production capacity to produce 50,000 units of textiles per week
or 10,000 automobiles per week – or some combination of the two. Vietnam on the other hand has the
production capacity to produce 10,000 units of textiles per week or 1,000 automobiles per week – or some
combination of the two.
Assume both countries face constant trade-offs (ie constant opportunity costs) as they switch production
from one good to the other.
a) Draw two graphs representing each country's production capacity in relation to these two goods.
b) Which country has the absolute advantage in the production of each good?
c) Which country has the comparative advantage in the production of each good?
d) Which country should produce/sell textiles?

What price would they find acceptable for textiles?
e) Which country should produce/sell automobiles?

What price would they find acceptable for automobiles?
f) State the range of trade terms which would benefit each country for textiles.
g) State the range of trade terms which would benefit each country for automobiles.
h) State a possible negotiated terms of trade Germany and Vietnam might reach. Express this terms of
trade in terms of each good.
i) Using the graphs you used in problem 2.a, draw a linear line representing each country's consumption
possibility frontier (assuming 100% specialization and a willingness to buy all of either good).
4. Represent the changes presented in each problem graphically by showing both the dollar market and the
Yen market. State whether each currency is appreciating or depreciating. When graphing a problem, be
sure to label everything – it should help you.
Determinants of Exchange Rates:
 Tastes related to imports and exports
 Relative incomes
 Relative price levels
 Relative real interest rates
 Speculation about future currency values
Akos Lada
[email protected]
Harvard Kennedy School
Summer Program 2014
 *Political Stability
a) The US economy takes a sharp upswing; and therefore, our per capita national income increases.
b) The US Treasury Department increases interest rates on their treasury notes (the bonds they’re selling).
c) Economic forecasters predict that inflation will be a problem in the latter half of the year (i.e., prices of
US goods and services are going up). How will this effect the dollar and Yen markets today?