Econ 001- Intro Econ Singapore Management University

Jungwon Yeo Term 1, 2011/12

Study Guide Problem Set 01

PART I: Review Questions

1. (True or False) Opportunity cost is the combined value of all other alternatives that go unchosen.

2. (True or False) Opportunity cost always arises when a trade-off decision is made.

3. Opportunity cost of a choice:
a. is relative prices for two of goods
b. is the slope of budget line in the two goods case.
c. is the value of the next best alternative the decision maker had to give up for the choice
d. determines who has an absolute advantage in production of a good
e. is the money cost for the choice


4. (True or False) The slope of a Production Possibilities Frontier is a graphic representation of
comparative advantage.

5. (True or False)The production possibilities frontier slopes downward and to the right because of
limited resources.

6. (True or False) Being on the PPF implies that in the production of one good or service can only
be accomplished by decreasing the quantity produced of another good or service.

7. (True or False) Free trade between two countries can be mutually beneficial as it is likely to shift
each countrys production possibilities frontier outwards.

8. The principles of comparative advantage explains how

a. one nation can take advantage of another one through international trade
b. two nations may engage in mutually beneficial trade, even though one of them is more
productive than the other
c. one individual can take advantage of another through international trade
d. some people are good at producing everything, while others have no comparative
advantage
e. some nations end up with large trade surpluses









Intro Econ Jungwon YEO
PS 01
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Figure 1



9. According to Figure 1, the opportunity cost of one more bushel of wheat is
a. higher at B than at D.
b. lower at B than at D.
c. equal at B and D.
d. impossible to determine from the information given.


10. The shape of the production possibilities frontier in Figure 1 implies that

a. the opportunity cost of producing more wheat falls as wheat production rises.
b. productivity of one input decreases as the quantity of the input increases given other
inputs are limited
c. the farmers technology is not subject to the principle of increasing costs.
d. the financial cost of producing wheat is higher than the financial cost of producing
barley.


11. Given the required hours to produce a desk and a chair, calculate Jennys opportunity cost of
producing desk and chair, respectively.
Desk Chair
Jenny 10 hours/desk 6 hours/chair


PART II: Basic Questions


12. Consider the following information regarding a persons decision to go to college: college tuition
is $25,000 per year, room and board is $15,000 per year, and books and materials are $3,000 per
year. Suppose that instead of going to college, this person could have earned $20,000 working for
OCBC, or $15,000 working for Cold Storage. An economist would calculate the cost of going to
college as
a. $15,000
b. $20,000
c. $25,000
d. $43,000
Intro Econ Jungwon YEO
PS 01
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e. $63,000
f. $78,000

(Educational Note: As no particular information about room and board in the case the person works is
given, assume the simplest case: that is, assume the annual income is the net income.)

13. In general, technological progress will






14. In an attempt to boost enrollment, in January, 1996, a private college in Iowa offered free tuition
for graduating high school seniors from the county where it is located. For students who accepted
the offer, how did this offer affect the economic cost of attending college?
a. The economic cost did not change, since lost earnings were still a factor.
b. The economic cost became zero for the typical student.
c. The economic cost was very low, because the only cost was for books and supplies.
d. The economic cost did not change, since tuition was not a factor in computing economic
cost.
e. The economic cost was lower than if tuition was charged, but there was still a cost.

15. Consider an economy with two people, Richard and Kelly. The economy only produces two
goods, snakeskin belts and fur hats. Richard and Kelly can produce the goods as follows:

Belts Hats
Richard 5 hours/belt 3 hours/hat
Kelly 2 hours/belt 6 hours/hat

Suppose Richard and Kelly each have 40 hours.
(a) Draw Richard and Kellys PPFs on separate graphs. For both graphs put belts on the Y-axis.
(b) Calculate the opportunity cost of producing belts for both Richard and Kelly. Be sure to include
the units.
(c) Calculate the opportunity cost of producing hats for both Richard and Kelly. Be sure to include
the units.
(d) Who has the comparative advantage in the production of belts? Why?
(e) Who has the absolute advantage in the production of belts? Why?




PART III: Applied Questions


17. (True or False) Waiting in line to get a free ticket does not involve any opportunity cost.




a. shift the production possibilities frontier outward, away from the origin.
b. reduce the slope of the production possibilities frontier, making it shallower.
c. increase the slope of the production possibilities frontier, making it steeper.
d. shift the production possibilities frontier inward, toward the origin.
e. make the production possibilities frontier more "bowed out."
Intro Econ Jungwon YEO
PS 01
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Figure 2


18. From the graph in Figure 2, the opportunity cost of a unit of cell phone is
a. 18 units of corn for USA; 6 units of corn for Korea
b. 9 units of cell phones for USA; 4 units of cell phones for Korea
c. 1/2 units of corn for USA; 2/3 units of corn for Korea
d. 2 units of corn for USA; 3/2 units of corn for Korea
e. None of the above is correct.

19. From Figure 2, one can infer that
a. USA has an absolute advantage in production of both goods.
b. Korea will be willing to export cell phones and import corn as long as the international
price of cell phone is greater than 2 units of corn.
c. USA will be willing to export corn and import cell phones if the international price of cell
phones is 1.7 units of corn.
d. If the international price of cell phones is 1.7 units of corn, point A will be on the Koreas
consumption possibilities frontier after trade.
e. Both a and c are correct.
(Hint: The two countries may have different capacities of resources.)

20. The following table describes the number of yards of cloth and barrels of wine that can be
produced with a weeks worth of labor in England and Portugal. Assume that no other inputs
are needed.


England Portugal
Cloth 8 yards 12 yards
Wine 2 barrels 6 barrels

(a) If there is no trade, what is the price of wine in terms of cloth in England and in Portugal?
(b) Suppose each country has 1 million weeks of labor available per year. Draw the production
possibilities frontier for each country.
(c) Which country has an absolute advantage in the production of which good(s)? Which country has
a comparative advantage in the production of which good(s)?
USA Korea
corn
cell phones 9
18
4
6
3
5 A
corn
cell phones
Intro Econ Jungwon YEO
PS 01
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(d) If the countries start trading with each other, which country will specialize and export which
goods? What can be said about the price at which trade will take place? (That is, what will be the
terms of trade?)
(e) Pick one price level at which trade will take place using your answer to part e. Draw the
consumption possibilities frontier for each country.
(f) Briefly discuss gains from trade based on your answer to part f.


21. Consider the information about a countrys production technology. Which of the following
shapes of production possibilities frontier is consistent with the given information?










car
tire
car
car car
a. b.
There are a fixed number of workers that exceeds 100 in the economy. Each worker allocated to
production of tires can produce 3 tires. Each worker allocated to production of cars can produce 1 car
until the number of cars produced is equal to 40. If the number of cars produced exceeds 40, each
additional worker allocated to production of cars can only produce 0.6 car.
tire
car
tire
tire tire
c. d.
e.
Econ 001- Intro Econ Singapore Management University
Jungwon Yeo Term 1, 2011/12

Answer Key to SG Problem Set 01

PART I: Review Questions

1. False: Opportunity cost is the combined value oI all other alternatives ( the value oI the next best
alternative) that go unchosen.

2. True
3. c
4. False: The slope oI a Production Possibilities Frontier is a graphic representation oI comparative
advantage.( opportunity cost)

5. True
6. True

7. False: Free trade between two countries can be mutually beneIicial as it is likely to shiIt each
country`s production( consumption) possibilities Irontier outwards.

8. b
9. b
10. b
11. OC oI a desk: 10/6 (1.67) chairs
OC oI a chair: 6/10(0.6) desks

PART II: Basic Questions
12. e. $63,000
13. a.
14. e
15.
(a)


Belts
Hats
40/3
6
Richard`s PPF
Hats
40/6
Belts
20
Kelly`s PPF
Intro Econ Jungwon YEO
PS 01-Answer Key
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(b) Richard could make 5/3 hats iI he spent 5 hours making hats, instead oI making a belt.
Hence, Richard`s opportunity cost oI producing a belt is 5/3 hats. Kelly`s opportunity cost oI
producing a belt is 1/3 hats.

(c) Richard`s opportunity cost oI producing a hat is 3/5 belts. Kelly`s opportunity cost oI
producing a hat is 3 belts.

(d) Kelly has the comparative advantage in the production oI belts because her opportunity cost
is lower than Richard`s.

(e)Kelly has the absolute advantage in the production oI belts as her input requirement is lower
than Richard`s.


PART III: Applied Questions


17. False (time is a very important resource which is limited)
18. d. 2 units oI corn Ior USA; 3/2 units oI corn Ior Korea (the slope oI a PPF is the opportunity
cost oI the good on the X-axis)

19. c

a. USA has an absolute advantage in production oI both goods
(This is not true as we do not know whether the two countries have the same amount oI
resources. II USA has more resources than Korea, its maximum amount oI a good that
can be produced can be bigger even iI Korea has an absolute advantage over the good.)
b. Korea will be willing to export cell phones and import corn as long as the international
price oI cell phone is greater than 2 units oI corn.
(Korea has a smaller opportunity cost than USA in production oI cell phones while USA
has a smaller opportunity cost than Korea in production oI corn. ThereIore, with trade,
Korea will produce and sell cell phones while USA will produce and sell corns. As
Korea`s cost oI production Ior 1 cell phone is 3/2 units oI corn, Korea will have
incentive to produce and sell cell phones as long as the price oI cell phone is greater than
or equal to 3/2 units oI corn)
c. USA will be willing to export corn and import cell phones iI the international price oI
cell phones is 1.7 units oI corn.
(As USA has a comparative advantage in corn production, USA will produce and sell
corn. As USA`s cost oI production Ior 1 unit oI cell phone is 2 units oI corn, USA will
have incentive to buy cell phones Irom Korea as long as the price oI cell phone is less
than or equal to 2 units oI corn.)
d. II the international price oI cell phones is 1.7 units oI corn, point A will be on the
Korea`s consumption possibilities Irontier aIter trade.
(II the international price oI 1 unit oI cell phone is 1.7 units oI corn, Korea will be able
to consume, by selling 1 unit oI cell phone, 3 units oI cell phone and 1.7 units oI corn.)
e. Both a and c are correct.

20.
Intro Econ Jungwon YEO
PS 01-Answer Key
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(a) The price oI wine in term oI cloth is equivalent to the opportunity cost oI wine. The price oI
wine oI one barrel is 4 yards oI cloths in England and 2 yards in Portugal.

(b)



(c) Portugal has absolute advantage in the production oI both goods because it requires less
input than England Ior the production oI both goods.
England has comparative advantage in cloth because it has the lower opportunity cost oI cloth
which is 1/4 barrels oI wine compared to Portugal`s opportunity cost oI cloth, which is 1/2
barrels oI wine. Portugal has comparative advantage in wine because it has the lower
opportunity cost oI wine which is 2 yards oI cloth compared to England`s opportunity cost oI
wine, which is 4 yards oI cloth.

(d) Each country will specialize in the production oI the good Ior which it has a comparative
advantage: England in cloth and Portugal in wine. England will participate in trade
voluntarily iI the price oI cloth is greater than 1/4 barrels oI wine. (iI one yard oI cloth is
exchanged Ior more than 1/4 barrels oI wine). Portugal will participate in trade voluntarily
iI the price oI wine is greater than 2 yards oI cloth. (iI one barrel oI wine is exchanged Ior
more than 2 yards oI cloth.) The price oI wine being greater than 2 yards oI cloth is
equivalent to the price oI cloth being smaller than 1/2 barrels oI wine. (That is, Portugal will
buy cloth Irom England iI the international price oI cloth is cheaper than the domestic price.)

ThereIore, 1/4 barrels oI wine international price oI cloth 1/2 barrels oI wine. (1 yard oI
cloth is exchanged Ior more than / barrels oI wine but less than barrels oI wine)

Equivalently, 2 yards oI cloth international price oI wine 4 yards oI cloth.


England Portugal
cloth (million
yards)
wine (million
barrels)
cloth (million
yards)
2
8
wine (million
barrels)
12
6
Intro Econ Jungwon YEO
PS 01-Answer Key
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(e)
I will assume the price oI cloth is 1/3 barrels oI wine, or equivalently the price oI wine is 3
yards oI cloths. At this price, trade will take place. The consumption possibilities Irontier Ior
each country at this price is given in the Iollowing graph in red.

(e) As shown in the above graph, with international trade, each country would be at least as
good as without the trade (except when Portugal`s preIerence asks Ior more than 8 million
yards oI cloth) While the consumption possibilities Irontier is equal to the production
possibilities Irontier without trade, the consumption possibilities Irontier shiIts outwards
aIter trade. This means that each country can choose either the consumption bundle it would
choose without trade or a consumption bundle which was not Ieasible without the trade.
ThereIore, both countries will get better oII, or at least as good as beIore, aIter international
trade.















England Portugal
cloth (million
yards)
wine (million
barrels)
2
8
wine (million
barrels)
12
6 8/3
8
10/3
cloth (million
yards)
Intro Econ Jungwon YEO
PS 01-Answer Key
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21. The opportunity cost oI 1 car is 3 tires (because to produce one more car, we must assign one
worker who could produce 3 tires to production oI cars) iI the number oI cars produced is less than
or equal to 40. The opportunity cost oI 1 car becomes 3/0.6 tires iI the number oI cars produced
exceeds 40. On the other hand, the opportunity cost oI 1 tire is 0.6/3 cars iI the number oI tires
produced is small to the extent that more than 40 cars are being produced. The opportunity cost oI
1 tire eventually becomes 1/3 cars as the number oI tires produced increases and hence the number
oI cars produced decreases.

Hence, the correct graphs are:

and


Educational Note 1: As we do not know how many workers are available, we cannot pin down the
X- and Y- intercepts. The main point is 'the opportunity cost changes, and it increases once

Educational Note 2: The PPF curve will be straight line (without a kink) only if both of two
productivities are constant. (In this question, productivity for tires is constant but
productivity for cars decreases)
tire
car
3
3/0.6
40
car
tire
0.6/3
1/3
40