ECON205 - S09

1. Who has the lowest opportunity cost?

Maria and Felix need to decide which one of them will take time off of work to complete the rather urgent task ofdigging post holes for their new fence. Maria is pretty good with a post auger; she can dig the holes in 30 minutes.Felix is somewhat slow; it takes him 5 hours to dig the holes. Maria earns $160 per hour as a psychiatrist, while Felixearns $20 per hour as a cobbler.

Keeping in mind that either Maria or Felix must take time off from work to dig the holes, who has the lowestopportunity cost of completing the task?

o Maria and Felix face identical opportunity costs

'" @ Mariao Felix

Explanation: Close A

If Maria decides to dig the holes, she gives up the $80 she could have earned working as a psychiatrist in the same30 minutes. If Felix decides to dig the holes, he gives up the $100 he could have earned working as a cobbler in thesame 5 hours. Since Maria gives up the least, she has the lowest opportunity cost of digging post holes for their newfence.

Scores: .:. Average: 1 / 1

2. Understanding opportunity cost

You work as an assistant coach on the university basketball team and earn $15 per hour. One day, you decide to skipthe hour-long practice and go to the movies instead, which has an $10 admission fee.

The opportunity cost of skipping practice and going to the movies, valued in dollars, is

ExpLanation:

$25 '" .

CLose A

When you measure the opportunity cost of a choice in dollars, you include any actual monetary amount paid (theexplicit cost) and the monetary value of any other sacrifices made (the implicit cost). By skipping practice, you forgoearning your hourly wage of $15 per hour, so this is your implicit cost. You also choose to pay $10 to get into themovies, so this is your explicit cost. So your opportunity cost in dollars, the sum of your explicit and implicit costs, is$15 + $10 = $25.

Scores: .:. Average: 1 /1

3. Efficiency in the production possibilities model

Suppose the United Kingdom produces barley and cars. Its current production possibilities frontier (PPF) is shown onthe diagram below, along with six output combinations labeled A through F.

CARS (Millions per year)

100

80C

X60

40

20

a

F 0X X

AX

PPFB

XE

X20 40 60 80 100

BARLEY [MiLLions ot bushels per year) I Clear All II Help I

Which of the points on the graph represent output combinations that are inefficient?

Explanation:

A and S only

Close /\.

The production possibilities frontier shows all efficient output combinations for the United Kingdom; that is,combinations of output that use all the nation's available resources and technology to their maximum potential.

Points located below the PPF, such as A and S, represent inefficient output combinations. At these points, it ispossible to increase the production of both goods because resources are unemployed. For example, point A isinefficient because it is possible for the United Kingdom to produce instead at point F, where the economy isproducing both more barley and more cars.

Which of the points on the graph represent output combinations that are efficient?

Explanation:

E and F only

Close /\.


Points located on the PPF, such as E and F, represent efficient output combinations. At these points, it isimpossible to increase the production of one good without producing less of the other. For instance, if the UnitedKingdom is currently producing at point F and decides that it wants to produce more barley, it must produce fewer

cars.

Which ot the points on the graph represent output combinations that are unattainable?

Explanation:

C and D only

Close A


Points located above the PPF, such as C and D, represent output combinations that are unattainable given currentresources and technology. Recall that each point on the PPFshows the maximum quantity of barley the UnitedKingdom can produce if it also wants to produce the given quantity of cars. For example, compare point F (40 millioncars and 40 million bushels of barley) with point D (40 million cars and 66 million bushels of barley). Because point Fis on the United Kingdom's PPF,we know that if the United Kingdom is producing 40 million cars, it can produce atmost 40 million bushels of barley; therefore, point D must be unattainable given current resources and technology.

Scores: 3 - - .:. Average: 3/3

4. The opportunity cost of shifting production choices 19The graph below shows the production possibilities frontier (PPF)of an economy that produces food and oil. The blackpoints (X symbols) represent three possible output levels in a given month. You can place your mouse over the points

to see their exact coordinates.

FOOD [Thousands of pounds per month)

40

35

30 A)( B

)(25 C

)(

20

15

10

5

0 20 40 60 80 100 120 140 160OIL (Thousands of barrels per month) I Clear All I ~

Suppose the economy initially produces 29,000 pounds of food and 20,000 barrels of oil, which is represented bypoint A. The opportunity cost of producing an additional 20,000 barrels of oil (that is, moving production to point B)

is 2,000 pounds of food.

Suppose instead that the economy currently produces 40,000 barrels of oil and 27,000 pounds of food, which isrepresented by point B. Now the opportunity cost of producing an additional 20,000 barrels of oil (that is, moving topoint C) is 3,000 pounds of food.

Comparing your answers to the two questions above, you can see that the opportunity cost of 20,000 additionalbarrels of oil at point B is greater than >/ the opportunity cost of 20,000 additional barrels of oil at point A. Thisreflects the law of increasing opportunity costs >/.


At point A, the economy produces 29,000 pounds of food and 20,000 barrels of oil. At point B, the economy produces27,000 pounds of food (2,000 fewer pounds than at point A) and 40,000 barrels of oil (20,000 more barrels than atpoint A). Therefore, at point A, the opportunity cost of 20,000 additional barrels of oil is 2,000 pounds of food.

At point S, the economy produces 27,000 pounds of food and 40,000 barrels of oil. At point C, the economy produces24,000 pounds of food (3,000 fewer pounds than at point S) and 60,000 barrels of oil (20,000 more barrels than atpoint B). Therefore, at point B, the opportunity cost of 20,000 additional barrels of oil is 3,000 pounds of food.

Since the opportunity cost of 20,000 additional barrels of oil starting at point A is 2,000 pounds of food, and theopportunity cost of 20,000 additional barrels of oil starting at point B is 3,000 pounds of food, the opportunity cost ofoil at point B is greater than the opportunity cost of oil at point A. This reflects the fact that in general, not allresources are equally well suited to the production of food and oil. When the economy starts producing oil, it usesthose resources that are most suited to oil production as opposed to food production. If this economy wants toproduce additional oil, it must start using resources that aren't as well suited to oil production; so the opportunitycost of the additional barrels of oil is higher than the cost of the initial barrels of oil. Therefore, the opportunity costof producing additional oil increases as more oil is produced, giving the PPFits familiar bowed-out shape.

Scores: 4 - - .: Average: 4 /4

5. Shifts in production possibilities

Suppose the United Kingdom produces both agricultural and capital goods. The diagram below shows its currentproduction possibilities frontier (PPF)for alfalfa, an agricultural good, and trucks, a capital good.

Drag the PPFto show the effects of a tightening of immigration laws to allow fewer workers into the country.

Tool tip: Position your cursor over any dots outlined in red and drag to the desired position. Dots will snap to theirnew position.

Answer

TRUCKSIThoLJsands per year)

30

20

TRUCKS(Thousands per year)

30

20 '

10

II C••.••L'o-l _ lR'_o 20

I40 60

ALFALFA[Millions of bLJshels per yeaI'I

10

o 20I

40 60

ALFALFA[Millions of bLJshels per yeaI'I


Becauseof the tightening of immigration laws, less labor is available for the production of either alfalfa or trucks. Thisdecreasesthe maximum amount of alfalfa the United Kingdom can produce for any given quantity of trucks, anddecreases the maximum number of trucks it can produce for any given quantity of alfalfa.

For instance, if we look at the vertical axis, we can see that if the United Kingdom produces zero bushels of alfalfa, itcan initially produce a maximum of 20,000 trucks per year. Becausethe tightening of immigration laws decreases theamount of trucks the United Kingdom can produce, you should have moved the point to 10,000 trucks per year.

Similarly, if we look at the horizontal axis, we can see that if the United Kingdom produces zero trucks, it can initiallyproduce a maximum of 40 million bushels of alfalfa per year. Because the tightening of immigration laws decreasesthe amount of alfalfa the United Kingdom can produce, you should have moved the point to 20 million bushels of

alfalfa per year.

Scores: .: Average: 1 / 1

6. Opportunity cost and production possibilities 19Nathan is a skilled toymaker who is able to produce both boats and puzzles. He has eight hours a day to produce

toys. The following table shows the daily output resulting from various possible combinations of his time.

Hours per Day Hours per Day Boats Puzzles

Choice Producing Boats Producing Puzzles Produced per Day Produced per Day

A 8 0 4 0

B 6 2 3 12C 4 4 2 19

D 2 6 1 21E 0 8 0 22

On the following diagram, use the red points (cross symbol) to plot Nathan's initial production possibilities frontier

(PPF). Plot your points in order, either from left to right or right to left. Line segments will connect the points

automatically.

Answer

PUZZLES PER DAY PUZZLES PER DAY

40 Initial PPF 40

"35 35

30 New PPF 30

25 25

20 <ll 0 20 0 00 0 0 0

15 150 0

10 10

5 5

-:> 0 00 2 3 4 5 6 7 8 0 2 3 4 5 6 7 8

BOATS PER DAY IClearAlll~ BOATS PER DAY

Explanation: Close '"

Each row of the table refers to one point on the production possibilities frontier. For example, if Nathan chooses to

spend all of his time producing boats, then he can produce 4 boats and no puzzles; so (4, 0) is one of the points on

his initial PPF. Similarly, if he splits his time evenly between producing boats and puzzles, he will produce 2 boats and

19 puzzles; so (2, 19) is another point on his initial PPF.

Suppose Nathan is currently choosing combination D, producing 1 boat per day. What is his opportunity cost of

producing a second boat per day? 2 puzzles per day"

Now suppose Nathan is currently choosing combination C, producing 2 boats per day. What is his opportunity cost of

producing a third boat per day? 7 puzzles per day

As Nathan increases his production of boats, his opportunity cost of producing one more boat

increases ".

Explanation: Close /'\

At combination D, Nathan is producing 1 boat and 21 puzzles each day. Producing a second boat each day wouldrequire him to move to combination C, reducing his production of puzzles to 19 per day. Since this change involvesproducing 21 - 19 == 2 fewer puzzles per day, the opportunity cost of producing the second boat per day is 2 puzzlesper day.

SimilarlYI at combination C, Nathan is producing 2 boats and 19 puzzles each day. Producing a third boat each daywould require him to move to combination 81 reducing his production of puzzles to 12 per day. Since this changeinvolves producing 19 - 12 == 7 fewer puzzles per day, the opportunity cost of producing the third boat per day is 7puzzles per day.

Nathan's opportunity cost of producing the second boat per day is 2 puzzles per day, while the opportunity cost ofproducing the third boat per day is 7 puzzles per day. Hence, as Nathan increases his production of boats, hisopportunity cost of producing more boats increases. This reflects the law of increasing opportunity costs.

Suppose Nathan buys a new tool that allows him to produce twice as many boats per hour as before, but doesn'taffect his ability to produce puzzles. Use the blue points (circle symbol) to plot his new PPFon the diagram above.Becausehe can now make more boats per hour, Nathan's opportunity cost of producing puzzles is

higher than" it was previously.

Explanation:

The new tool causes Nathan's PPFto pivot to the right. In other words, for each point on his PPF,the verticalcoordinate is the same as before, but the horizontal coordinate is twice its initial value.

Close /'\

For example, consider combination D, in which Nathan spends 2 hours producing boats and 6 hours producingpuzzles. Before he bought the new tool, he could have produced 1 boat and 21 puzzles, so (1, 21) was a point on hisinitial PPF.With the new tool, the same allocation of time results in 2 boats and 21 puzzles, so (2, 21) is a point on

his new PPF.

The shift in Nathan's PPFis reflected in a corresponding change in his opportunity costs. Again, consider combinationD, and consider the effects of moving from there to combination E. 80th before and after Nathan buys the tool, hecan produce 21 puzzles if he devotes 6 hours to producing them, and 22 puzzles if he devotes 8 hours to producingthem. Hence, spending his last 2 hours producing puzzles results in 1 additional puzzle. Before he bought the tool,that would have meant giving up 1 boat; but now that he has the tool, it means giving up 2 boats. Therefore,Nathan's increased ability to produce boats increases his opportunity cost of producing puzzles.

Scores: 6 - .:. Average: 6/6

7. Economic growth and PPFs

The blue curve on the graph below shows the current production possibilities frontier (PPF) for the economy of

Wilshire, while the red curve shows the PPFfor Wilshire next year if the economy were to operate at point B today.

CONSUMPTION GOODS

A- ->.c

I B-- .•.-----X

I I

I II II I

I- -1- - - - - r - -~C

I I I PPFI I I Today

PPFNext Year

CAPITAL GOODS

Suppose that this year, the economy is operating at point B, and a technological advance occurs that enables greater

production of either capital goods or consumption goods with the same resources. On the following graph, the PPF

that best describes the Wilshire economy next year is PPF3 (green line) . (Note: The blue and red PPFs are

the same as on the graph above.)

CONSUMPTION GOODS

l PPFTodilY

PPFl I PPF2 PPF3'--

Explanation:

CAPITAL GOODS

Close A

An economy faces the tradeoff between current production of consumption goods and current production of capitalgoods. The more resources an economy devotes to producing consumption goods, the higher the standard of livingnow, but the fewer capital goods it can produce today. Greater capital, however, is one of the major sources ofeconomic growth. Therefore, you can expect an otherwise identical economy to grow more quickly when it producesmore capital.

Becausecapital is itself a resource, this economy will have more resources in the future as a result of thetechnological innovation. Therefore, the appropriate PPFis the one further out than the red PPF,namely PPF3.

Scores: •:. Average: 1 / 1

8. Specialization and production possibilities 19

Suppose France produces only cars and trucks. The resources that are used in the production of these two goods arenot speCialized-that is, the same set of resources is equally useful in producing each good.

The graphs below show two possible PPFsfor France's economy, a straight line PPF(PPF1)and a bowed out PPF

(PPF2)'

TRUCKS

Graph 1

PPFl

CARS

TRUCKS

Graph 2

PPF2

CARS

Based on the above description, the tradeoff France faces between producing trucks and cars is best represented by

Graph 1

The shape of the PPFreflects the fact that as France produces more cars and fewer trucks, the opportunity cost ofproducing each additional car remains constant../ .


You are told in this problem that the same set of resources is equally useful in producing each good. Thus, if Francedecides to produce more cars and fewer trucks, the resources that it uses to produce the additional cars will be aswell suited to the production of cars as the resources already being used in car production. Therefore, the opportunitycost of producing each additional car remains constant as more cars are produced.

The opportunity cost of producing cars is reflected in the slope of the PPF.If the PPFis flatter, producing an additionalcar requires giving up fewer trucks. If the PPFis steeper, producing an additional car requires giving up more trucks.

In this case, because the opportunity cost of producing additional cars remains constant as more resources areshifted to the production of cars, the slope of the PPFmust remain constant as France produces more trucks andfewer cars. Therefore, the tradeoff France faces between producing trucks and cars is best represented by Graph 1.

9. Comparative and absolute advantage

Nathan and Ginny run a catering business in which they have two major tasks: getting new clients and preparingfood for events and parties. It takes Nathan 12 hours to prepare the food for an event and 3 hours of effort to geteach new client. For Ginny, it takes 8 hours to prepare food for an event and 4 hours to get a new client.

In this scenario, Ginny" has an absolute advantage in food preparation, and __ G_in_n_y__ has a comparativeadvantage in food preparation.

Explanation: Close /\.

Ginny has an absolute advantage in food preparation because she can do it in less time (8 hours) than Nathan can(12 hours). Ginny also has a comparative advantage in food preparation, because her opportunity cost of preparingfood for one more event (2 new clients) is lower than Nathan's opportunity cost of preparing food for one more event(4 new clients).

Suppose that initially, Nathan and Ginny are both splitting both tasks for a large number of events. Then they decideto start shifting some work according to the principle of comparative advantage. In particular, the person with thecomparative advantage in food preparation will take over preparing food for one more event, and the other personwill use the freed-up time to get more clients. As a result, the total number of events for which food is prepared willremain unchanged, but the number of new clients will increase by 2 " .

Explanation: Close /\.

When Ginny (who has a comparative advantage in food preparation) takes over preparing food for one event, shehas to shift 8 hours away from getting clients. This causes Ginny to attract 2 fewer clients. But by freeing Nathanfrom having to prepare food for one event, Nathan can shift 12 hours to getting new clients. Because it takes Nathan3 hours to get a new client, in 12 hours he can get 4 new clients. Thus, Ginny gets 2 fewer clients, but Nathan gets 4more clients. In the end, new clients increase by 4 - 2 = 2.

Scores: 3 - - •• Average: 3/3

10. Comparative advantage

Jamal and Karen are farmers. Each one owns a 10-acre plot of land. The table below shows the amount of alfalfa andcorn each farmer can produce per year on a given acre. Both farmers can choose whether to devote all 10 acres toproducing alfalfa, devote all 10 acres to producing corn, or produce alfalfa on some of their land and corn on the rest.

Jamal

Karen

Alfalfa(Bushels per acre)

2012

Corn(Bushels per acre)

5

4

On the following diagram, use the red line (cross symbols) to plot Jamal's production possibilities frontier (PPF),anduse the blue line (circle symbols) to plot Karen's PPF.

Answer

ALFALFA [Bushels per year)

300

250

200

150

o100

50

Jamal's PPF

Karen's PPF

ALFALFA [Bushels per year]

300

250

200 '0

150

o100

50

o

Explanation:

o ;:>10 20 30 40 50 60 70 80

CORN IBushels per year] lClear All J lHelp J

oo ;:>

10 20 30 40 50 60 70 80CORN [Bushels per year!

Close A

From the table above, you can see that if Jamal devotes all 10 acres to producing alfalfa, then he can produce 10acres x 20 bushels per acre = 200 bushels of alfalfa per year. On the other hand, jf he uses all 10 acres to producecorn, then he can produce 10 acres x 5 bushels per acre = 50 bushels of corn per year. Therefore, his PPFextends

from (0, 200) to (50, 0).

Similar calculations for Karen show that if she devotes all of her land to producing alfalfa, then she can produce 120bushels of alfalfa per year. On the other hand, if she uses all 10 acres to produce corn, then she can produce 40bushels of corn per year. Therefore, her PPFextends from (0, 120) to (40, 0).

Notice that both PPFsare linear because there is a constant tradeoff between the two goods.

Jamal has an absolute advantage in the production of alfalfa andthe production of corn.

Explanation:

Jamal has an absolute advantage In

Close A

Someone has an absolute advantage in the production of a good if he or she can produce a unit of output using fewerresources than someone else. Here, the only resource we are considering is land.

Jamal needs 1/20 of an acre to produce a bushel of alfalfa, and Karen needs 1/12 of an acre to produce the sameamount. Therefore, Jamal has an absolute advantage in the production of alfalfa.

Likewise, Jamal needs 1/5 of an acre to produce a bushel of corn, and Karen needs 1/4 of an acre to produce thesame amount. Therefore, Jamal has an absolute advantage in the production of corn.

Jamal's opportunity cost of producing 1 bushel of corn is 4 bushels of alfalfa , whereas Karen's opportunitycost of producing 1 bushel of corn is 3 bushels of alfalfa . BecauseJamal has a higher opportunity costof producing corn than Karen, Karen has a comparative advantage in the production of corn and Jamalhas a comparative advantage in the production of alfalfa.


For each acre Jamal uses to produce corn, he produces 5 bushels of corn per year. But using that acre to producecorn means he must forgo the 20 bushels of alfalfa he could have produced on that land. Therefore, Jamal'sopportunity cost of producing 5 bushels of corn is 20 bushels of alfalfa, so the opportunity cost of producing eachbushel of corn is 20 bushels of alfalfa / 5 bushels of corn = 4 bushels of alfalfa per bushel of corn. (Note also that theslope of Jamal's PPFis -4.)

By the same logic, Karen could use an acre of land to produce either 4 bushels of corn or 12 bushels of alfalfa, so heropportunity cost of producing corn is 12 bushels of alfalfa / 4 bushels of corn = 3 bushels of alfalfa per bushel ofcorn. (Again, note that the slope of Karen's PPFis -3.)

Someone has a comparative advantage in producing a good if they can produce it at a lower opportunity cost thansomeone else. In this case, Jamal has a higher opportunity cost of producing corn than Karen, so Karen has acomparative advantage in the production of corn. Note that the opposite is true of alfalfa: repeating the calculationsabove, we can see that Jamal's opportunity cost of producing a bushel of alfalfa is 1/4 bushel of corn, and Karen'sopportunity cost of producing a bushel of alfalfa is 1/3 bushel of corn. Therefore, Jamal has a comparative advantagein the production of alfalfa.

Note that although it is possible for one person to have an absolute advantage in the production of both goods, it isimpossible for one person to have a comparative advantage in both goods. Since Karen has a lower opportunity costof producing corn than Jamal, it must be the case that Jamal has a lower opportunity cost of producing alfalfa thanKaren.

Scores: 9 .: Average: 9 /9

Documents

ECON205 - S09