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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