# 1. Suppose the following table reflects the domestic supply and demand for compact discs (CDs)

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## PROBLEMS

1. Suppose the following table reflects the domestic supply and demand for compact discs (CDs):

 Price (\$) 16 14 12 10 8 6 4 2 Quantity Supplied 8 7 6 5 4 3 2 1 Quantity Demanded 2 4 6 8 10 12 14 16

a. Graph these market conditions and identify the equilibrium price and sales.

b. Now suppose that foreigners enter the market, offering to sell an unlimited supply of CDs for \$6 apiece. Illustrate and identify (1) the market price, (2) domestic consumption, and (3) domestic production.

c. If a tariff of \$2 per CD is imposed, what will happen to (1) the market price, (2) domestic consumption, and (3) domestic production?

a. Equilibrium price is \$12 and equilibrium quantity is 6.

Before tariff

After tariff

b. Illustrated as dotted lines in the diagram. The new market price is \$6, domestic consumption is 12, and domestic production is 3.
c. The market price would increase to \$8, domestic consumption is 10, and domestic production is 4.

2. Alpha and Beta, two tiny islands off the east coast of Tricoli, produce pearls and pineapples. The production-possibilities schedules in the table below describe their potential output in tons per year:

a. Graph the production possibilities confronting each island.

b. What is the opportunity cost of pineapples on each island (before trade)?

c. Which island has a comparative advantage in pearl production?

(a) The production possibilities of the two

islands.
 Alpha Beta Pearls Pineapples Pearls Pineapples 0 30 0 20 2 25 10 16 4 20 20 12 6 15 30 8 8 10 40 4 10 5 45 2 12 0 50 0

(b) The opportunity cost is what you have to give up in order to get the next best alternative. In this case, Alpha and Beta can either produce pineapples or pearls with their resources. If all of Alpha’s resources are dedicated to producing pearls, it can produce 12. If its resources are used to produce pineapples, it can produce 30. This is a ratio of 12/30 or 2/5 pearls must be given up for each pineapple produced. In Beta the ratio is 2 1/2 pearls for each pineapple.

(c) Beta will have the comparative advantage in pearls because it can produce pearls at a lower opportunity cost, 2/5 pineapples compared to 2 ½ pineapples for Alpha.
3. Suppose the two islands in problem 2 agree that the terms of trade will be 1 pineapple for 1 pearl and that trade soon results in an exchange of 10 pearls for 10 pineapples.

a. If Alpha produced 6 pearls and 15 pineapples and Beta produced 30 pearls and 8 pineapples before they decided to trade, how much would each be producing after trade became possible? Assume that the two countries specialize just enough to maintain their consumption of the item they export, and make sure each island trades the item for which it has a comparative advantage.

b. How much would the combined production of pineapples increase for the two islands due to trade? How much would the combined production of pearls increase?

c. How could both countries produce and consume even more?

a. Alpha increases production of pineapples from 15 to 25 while decreasing pearl production from 6 to 2, while Beta increases pearl production from 30 to 40 while decreasing pineapple production from 8 to 4. This specialization reflects the opportunity costs facing the two islands.
b. Pearl production has increased from 36 pearls to 42 while pineapple production has increased from 23 to 29.
c. By switching production to the most efficient producer, total world production increases allowing for increased consumption of both goods by both island nations.
4. What is the equilibrium euro price of the U.S. dollar?

a. in Figure 17.3?

b. in Figure 17.4?

c. did the dollar appreciate or depreciate in Figure 17.4?

a. In Figure 17.3, the equilibrium price of the euro, in U.S. dollars, is \$ 0.80.

b. In Figure 17.4, the equilibrium price of the euro, in U.S. dollars, is \$ 0.85.

c. The dollar depreciated in value because it now takes less euros (1.18) to purchase a U.S. dollar compare to previously (1.25).
5. In what country is the U.S. dollar price of a Big Mac (p. 379) the highest with the following exchange rates:

a. 7,945 rupiah = \$1

b. 0.8 euros= \$1

c. 38 baht = \$1

d. 1.70 swiss franc = \$1
To answer this question, you must first convert the price of the Big Mac into U.S. dollars. The information provided in the text on page 379 indicates the prices were:

Jakarta, Indonesia – 16,155 rupiah

Rome – 2,75 euros

Bangkok – 55 baht

Geneva – 5.90 franc

 City Exchange Rate \$ Price Jakarta 7,945 rupiah = \$1 16,155/7,945 = \$2.03 Rome 0.8 euros = \$1 2.75/0.8=\$3.44 Bangkok 38 baht = \$1 55/38=\$1.45 Geneva 1.70 swiss franc = \$1 5.90/1.7=\$3.47

6. If a Gameboy SP costs 10,000 yen in Japan, how much will it cost in U.S. dollars if the exchange rate is:

a. 120 yen = \$1

b. 1 yen = \$0.00833

c. 100 yen = \$1
a. \$83.33 = 10,000 yen/120 yen per dollar

b. \$83.33 = 10,000 yen/120 yen per dollar (If 1 yen = \$ .00833, then \$1 = 120 yen, i.e. 1/.00833.)

c. \$100 = 10,000 yen/100 yen per dollar.
7. How much added income did U.S. sugar-beet farmers earn as a result of higher sugar prices (see Headline, p. 394)?
The higher prices gave the farmers an additional \$1.5 billion.

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