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Country A currently produces 200 units of food and 500
units of textiles. Country B produces 800 units of food and 300 units of
textiles.
1. Estimate the opportunity cost for each of textiles in terms of food.
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Country A |
Country B |
| At 200 food, 500 textiles, estimate the opportunity cost as the -slope of the PPF at that point (marked with a 'o' on the PPF). The slope is approximately -2. The opportunity cost is 2. | At 800 food, 300 textiles, estimate the opportunity cost as the -slope of the PPF at that point (marked with a 'o' on the PPF). The slope is approximately -1. The opportunity cost is 1. |
2. If trade were to take place, which country would produce more food
and which would produce more textiles? Explain.
"A" should produce more food because for "A,"
the opportunity cost of textiles is higher. That is, it is more expensive
for "A" to produce textiles than it is for "B."
3. Show the effect on Country A's PPF of a new textile manufacturing
technology.
The gray line on the graph could represent such a change: no increase
in food but more textiles are possible.
4. Show the effect on Country B's PPF of a severe drought.
Either of the gray lines on the graph could represent such a change: either no change in textiles and a drop in food production or declines in both.
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Event 1. Corn and alfalfa (cattle feed) prices rise due to bad weather. |
Event 2. Consumers abandon the "low-fat diet." (hint: milk is fattening) |
Policy 3. The federal government allows the use of a growth hormone that increases the amount of milk a cow will produce. |
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Effect on Demand |
no change |
increase |
decrease* |
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Effect on Supply |
decrease |
no change |
increase |
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Effect on Usage |
decrease |
increase |
uncertain |
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Effect on Price |
increase |
increase |
decrease |
* That demand will decrease is evident from the news reports that surrounded the introduction of the "bovine growth hormone" (BGH) and the response of dairies: offering non-BGH milk to win back some consumers. Partial credit was assigned for the answers in parentheses.
| Event 1. Corn and alfalfa (cattle feed) prices rise due to bad weather. | Event 2. Consumers abandon the "low-fat diet." (hint: milk is fattening) | Policy 3. The federal government allows the use of a growth hormone that increases the amount of milk a cow will produce. |
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In a study commissioned by the College, consultants estimate that an increase in the comprehensive fee from $19,550 to $20,500 would cause the number of returning students to drop by 2%. Also, it would reduce applications for next year's class from 1600 to 1460.
a) Estimate and interpret the price elasticity of demand by the returning students.
elasticity = (%dQ)/(%dP)
%dQ = -2% and %P = (($20,500-$19,550)/$19,550)100% = 4.86%
elasticity = -2%/4.86% = -0.412
demand is inelastic
b) Estimate and interpret the price elasticity of demand by applicants.
elasticity = (%dQ)/(%dP)
%dQ = ((1460-1600)/1600)100% = -8.75% and %dP = = 4.86% from above
elasticity = -8.75%/4.86% = -1.8
demand is elastic
c) Comparing these elasticities, do they seem reasonable? Explain.
Yes, they do seem reasonable. The demand for St. Olaf by returning students should be less elastic as they have fewer options (substitutes). Applicants can choose from a host of other schools. The more available substitutes are, the more elastic demand will be.
a) FC=3000. Find this by multiplying any of the AFC figures by Q (e.g., at Q=10, AFC=300: FC=300x10=3000).
b) Industry supply and demand should be drawn with an equilibrium price of $280 (find price from TR = P x Q. E.g., @ Q=10, TR=2800: P=TR/Q=2800/10=280). The graph of MC and ATC is shown below. AVC is shown for reference. The firm's quantity is chosen where P=MC (Q=48) but a quantity of 40 would be correct too.
c) At a price of $50, the firm would produce nothing (shut down) because P < AVC. At a price of $450 the firm would produce 60 (or 65, interpolating) because this is the quantity where P=MC.
(a) What price will ABC select for Wide Seat jeans? How
many will be sold?
ABC will select a quantity of 2500 and a price of $55:
Q where MR = MC, P along demand.
(b) What is the amount of ABC's fixed costs in dollars?
Find FC by first finding AFC = ATC - AVC at any of
the points along ATC. Then multiply AFC by Q. E.g., @ Q=1000, ATC=$60,
AVC=$30: AFC=($60-$30)=$30, FC=$30 x 1000 = $30,000
(c) How much will ABC's profits be? Show this on the graph
as well.
Find profits by subtracting total costs (TC) from total
revenues (TR). TC = ATC x Q = $42 x 2500 = $105,000. TR = P x Q = $55 x
2500 = $137,500. Profits = $137,500 - $105,000 = $32,500.
(d) What is the allocatively efficient price and quantity?
Why is it not feasible?
The allocatively efficient price and quantity are where P = MC: P = 30, Q = 5,000. This is not feasible because at this point the firm would have a negative profit (a loss, seen by ATC above price, P). In the long run, the firm would choose to exit from the industry if it could not make a profit.
