Download Problem 1 (20 points) (a) Country A Country B (b) Country B has

Problem 1 (20 points)
(a) Country A
Country B
Food
Food
600
Slope=3
Slope=1
120
40
Clothin
600
Clothin
(b) Country B has absolute advantage in the production of clothing, because a worker produces more clothing in
Country B (6>1)
(c) Country B has comparative advantage in the production of clothing, because opportunity cost of clothing is lower
in Country B (1<3)
(d) Country B needs to produce 300-60=240 units of food. They need 240/6=40 workers to produce food. They have
100-40=60 workers to produce clothing. They can produce 6*60=360 units of clothing. Since they need to give 30
units of clothing to Country A, they can consume 360-30=330 units of clothing.
(e) Country A’s consumption:
In the absence of trade: 60 units of food and 20 units of clothing.
Under this agreement: 120-60=60 units of food and 30units of clothing.
Country B’s consumption:
In the absence of trade: 300 units of food and 300 units of clothing
Under this agreement: 300 units of food and 330 units of clothing
Both countries will agree, because both consume the same amount of food and more clothing under the agreement.
Problem 2 (15 points)
(a)
S2
P
S1
E2
P2
E1
$5
S2
D1
S2
O
Q
800
1000
Since the government prohibits farmers from growing more than 800 bushels of wheat, and 800<1000, the quantity
control is binding. The supply curve will be changed from S1 to S2; consequently, the equilibrium will change from E1
to E2. At this new equilibrium, the new price will be P2, which is higher than the original price $5.
(b)
P
S1
S3
E1
$5
P3
E3
D1
O
Q
Q3
1000
If the government does not restrict the quantity of wheat farmers can grow, then the decrease in input prices for the
production of wheat will shift the supply curve to the right, from S1 to S3, as shown above. Consequently, the
equilibrium will change from E1 to E3, hence the new equilibrium price P3 will be less than $5, and the new
equilibrium quantity Q3 will be greater than 1000 bushels.
(c)
S2
S4
P
S1
S3
E2
P2
E1
$5
S2
S4
D1
S2
S4
O
800
1000
Q
If the input prices fall AND the government imposes a quantity control of 800 bushels, the new supply curve will be
S4, as shown above. Since the demand curve is the same D1, the new equilibrium will still be at E2, which is also the
intersection between D1 and S4. Therefore, in this case, the equilibrium price will still be P2, and the equilibrium
quantity will still be 800, which are exactly the same as the results we saw in Part (a). Equilibrium price does not
change.
Problem 3 (15 points)
(a) The new equilibrium price P1 will be less than P0. The new equilibrium quantity Q1 will be less than Q0
P
S0
P0
P1
D1
Q1
Q0
D0
Q
(b) Comparison with the initial equilibrium
Quantity will definitely be lower. Price can be either greater or less than the initial equilibrium.
Comparison with the equilibrium in (a)
Price will be definitely greater and quantity will be definitely less.
Therefore,
it is possible that the new equilibrium price P2 will be greater than P0.
it isn’t possible that the new equilibrium quantity Q2 will be greater than Q0.
it is possible that the new equilibrium price P2 will be greater than P1.
it isn’t possible that the new equilibrium quantity Q2 will be greater than Q1
P
S2
S0
P2
P0
P1
D1
Q2
Q1
Q0
D0
Q
Multiple Choice answer key
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22
A&B
A C B C B B B C C B D A D A B D B C B B C D
C&D
B C B D C C D A C B C B B A D A B D B C B B