Chapter 2 Draw a production possibility frontier for Bermuda

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Solution

1. Two important industries on the island of Bermuda are fishing and tourism.

According to data from the Food and Agriculture Organization of the United Nations

and the Bermuda Department of Statistics, in 2009 the 306 registered fishermen in

Bermuda caught 387 metric tons of marine fish. And the 2,719 people employed by

hotels produced 554,400 hotel stays (measured by the number of visitor arrivals).

1. a. Forgoing the production of 1 metric ton of fish allows Bermuda to produce 2,000

additional hotel stays. Therefore, forgoing the production of 387 metric tons of

fish allows Bermuda to produce 2,000 × 387 = 774,000 additional hotel stays. If

all fishermen worked in the hotel industry, Bermuda could produce

554,000 + 774,000 = 1,328,400 hotel stays.

Quantity of

hotel stays

(thousands)

1,328.4

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CHAPTER

Economic Models:

Trade-offs and Trade

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Solution

2. According to data from the U.S. Department of Agriculture’s National Agricultural

Statistics Service, 124 million acres of land in the United States were used for wheat

or corn farming in a recent year. Of those 124 million acres, farmers used 50 mil-

lion acres to grow 2.158 billion bushels of wheat and 74 million acres to grow 11.807

billion bushels of corn. Suppose that U.S. wheat and corn farming is efficient in

production. At that production point, the opportunity cost of producing 1 addi-

2. a. This point is feasible but not efficient in production. Producing 1.8 billion bushels

of wheat and 9 billion bushels of corn is less of both wheat and corn than is pos-

sible. They could produce more if all the available farmland were cultivated.

than 1.7 bushels of corn.

c. This new production point is feasible and efficient in production. Along the pro-

3. In the ancient country of Roma, only two goods, spaghetti and meatballs, are pro-

duced. There are two tribes in Roma, the Tivoli and the Frivoli. By themselves, the

Tivoli each month can produce either 30 pounds of spaghetti and no meatballs,

or 50 pounds of meatballs and no spaghetti, or any combination in between. The

Frivoli, by themselves, each month can produce 40 pounds of spaghetti and no meat-

balls, or 30 pounds of meatballs and no spaghetti, or any combination in between.

a. Assume that all production possibility frontiers are straight lines. Draw one

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Solution

3. a. The accompanying diagram shows the production possibility frontier for the Tivoli in

panel (a) and for the Frivoli as the line labeled “Original Frivoli PPF” in panel (b).

Quantity

of spaghetti

(pounds)

(a) Production possibility frontier

for the Tivoli

Quantity

of spaghetti

(pounds)

Original Frivoli PPF

(b) Production possibility frontier

for the Frivoli

The production possibility frontier for the Tivoli was calculated as follows: the

Tivoli can produce either 30 pounds of spaghetti and no meatballs, or they can

produce no spaghetti but 50 pounds of meatballs. That is, the opportunity cost

b. For the Tivoli, the opportunity cost of 1 pound of meatballs is

⁄

of a pound

of spaghetti. For the Frivoli, the opportunity cost of 1 pound of meatballs is

⁄

pounds of spaghetti. That is, the Tivoli have a comparative advantage in meatball

production because their opportunity cost is lower. For the Tivoli, the opportunity

cost of 1 pound of spaghetti is

⁄

pounds of meatballs. For the Frivoli, the oppor-

tunity cost of 1 pound of spaghetti is

⁄

pound of meatballs. That is, the Frivoli

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Solution

4. One July, the United States exported aircraft worth $1 billion to China and imported

aircraft worth only $19,000 from China. During the same month, however, the

United States imported $83 million worth of men’s trousers, slacks, and jeans from

China but exported only $8,000 worth of trousers, slacks, and jeans to China. Using

4. a. Since countries gain from specializing in production of the goods and services in

which they have a comparative advantage, the United States must have the com-

5. Peter Pundit, an economics reporter, states that the European Union (EU) is increas-

ing its productivity very rapidly in all industries. He claims that this productivity

advance is so rapid that output from the EU in these industries will soon exceed that

of the United States and, as a result, the United States will no longer benefit from

trade with the EU.

a. Do you think Peter Pundit is correct or not? If not, what do you think is the

source of his mistake?

5. a. Peter Pundit is not correct. He confuses absolute and comparative advantage. Even

if the EU had an absolute advantage over the United States in every product it pro-

6. You are in charge of allocating residents to your dormitory’s baseball and basketball

teams. You are down to the last four people, two of whom must be allocated to base-

ball and two to basketball. The accompanying table gives each person’s batting aver–

age and free – throw average.

S-14 CHAPTER 2 ECONOMIC MODELS: TRADE-OFFS AND TRADE

Name Batting average Free-throw average

Kelley 70% 60%

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Solution

b. Why is it likely that the other basketball players will be unhappy about this

arrangement but the other baseball players will be satisfied? Nonetheless, why

would an economist say that this is an efficient way to allocate players for your

dormitory’s sports teams?

6. a. Let’s begin by establishing the opportunity cost of free throws for each player. If

you allocate Kelley to the basketball team, the team gains a player with a 60%

free – throw average and the baseball team loses a player with a 70% batting aver–

age. That is, the opportunity cost of allocating Kelley to the basketball team is

⁄

Similarly, Jackie’s opportunity cost of playing basketball is 1; Curt’s opportunity

7. The inhabitants of the fictional economy of Atlantis use money in the form of cowry

shells. Draw a circular-flow diagram showing households and firms. Firms produce

potatoes and fish, and households buy potatoes and fish. Households also provide

7. The accompanying diagram illustrates the circular flow for Atlantis.

Shells Shells

Households

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Solution

a. The flooding of the fields will destroy the potato crop. Destruction of the potato

crop reduces the flow of goods from firms to households: fewer potatoes produced

by firms now are sold to households. An implication, of course, is that fewer

cowry shells flow from households to firms as payment for the potatoes in the

8. An economist might say that colleges and universities “produce” education, using

faculty members and students as inputs. According to this line of reasoning, educa-

tion is then “consumed” by households. Construct a circular-flow diagram to repre-

8. The accompanying diagram shows the circular flow for the education sector.

Tuition

Salaries,

scholarships

Faculty,

students

Education

Households

Education

market

Academic job

market, market

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Solution

9. Your dormitory roommate plays loud music most of the time; you, however, would

prefer more peace and quiet. You suggest that she buy some earphones. She responds

that although she would be happy to use earphones, she has many other things that

she would prefer to spend her money on right now. You discuss this situation with a

friend who is an economics major. The following exchange takes place:

He: How much would it cost to buy earphones?

You: $15.

He: How much do you value having some peace and quiet for the rest of the semester?

You: $30.

He: It is efficient for you to buy the earphones and give them to your roommate. You gain

more than you lose; the benefit exceeds the cost. You should do that.

You: It just isn’t fair that I have to pay for the earphones when I’m not the one making

the noise.

a. Which parts of this conversation contain positive statements and which parts

contain normative statements?

9. a. “It is efficient for you to buy the earphones” is a positive statement (it is either

right or wrong); that is, it is about description. “You should do that” (that is,

buy the earphones) is strictly speaking a normative statement; that is, it is about

prescription (although you would find all economists agree that all trades that

10. A representative of the American clothing industry recently made the following state-

ment: “Workers in Asia often work in sweatshop conditions earning only pennies

an hour. American workers are more productive and as a result earn higher wages.

In order to preserve the dignity of the American workplace, the government should

enact legislation banning imports of low – wage Asian clothing.”

a. Which parts of this quote are positive statements? Which parts are normative

statements?

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Solution

10. a. The positive statements are:

■ workers in Asia . . . [are] earning only pennies an hour

■ American workers are more productive

■ American workers are more productive and as a result earn higher wages

11. Are the following statements true or false? Explain your answers.

a. “When people must pay higher taxes on their wage earnings, it reduces their

incentive to work” is a positive statement.

11. a. True. This is a positive statement. It has a factual answer; that is, it is either right

or wrong. There has been some debate about whether the statement is actually

true or false, but in principle there is only one answer.

b. False. This is a statement about what we should do, and this statement has no

clearly right or wrong answer. Your view will depend on whether you think

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Solution

12. Evaluate the following statement: “It is easier to build an economic model that accu-

rately reflects events that have already occurred than to build an economic model to

12. True. With hindsight it is easier to see the important features of the situation that

a model should have captured. For predictive purposes, a model needs to anticipate

13. Economists who work for the government are often called on to make policy recom-

mendations. Why do you think it is important for the public to be able to differenti-

ate normative statements from positive statements in these recommendations?

13. Positive statements are those based on fact—or at least on our best estimate of what

the facts are. Therefore, these statements are also those that do not depend on the

14. The mayor of Gotham City, worried about a potential epidemic of deadly influenza

this winter, asks an economic adviser the following series of questions. Determine

whether a question requires the economic adviser to make a positive assessment or a

normative assessment.

a. How much vaccine will be in stock in the city by the end of November?

b. If we offer to pay 10% more per dose to the pharmaceutical companies providing

14. a. Positive

b. Positive

15. Assess the following statement: “If economists just had enough data, they could solve

all policy questions in a way that maximizes the social good. There would be no need

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Solution

15. What is true is that if economists had enough data, they could predict precisely

what the outcome would be of any proposed policy (such as free medical care). That

16. Atlantis is a small, isolated island in the South Atlantic. The inhabitants grow pota-

toes and catch fish. The accompanying table shows the maximum annual output

combinations of potatoes and fish that can be produced. Obviously, given their lim-

ited resources and available technology, as they use more of their resources for potato

production, there are fewer resources available for catching fish.

16. a. The accompanying diagram shows the production possibility frontier for Atlantis.

600

650

Quantity

of fish

(pounds)

675

S-20 CHAPTER 2 ECONOMIC MODELS: TRADE-OFFS AND TRADE

Maximum annual Quantity of potatoes Quantity of fish

output options (pounds) (pounds)

A 1,000 0

B 800 300

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b. No, Atlantis cannot produce 500 pounds of fish and 800 pounds of potatoes. If

it produces 500 pounds of fish, the most potatoes it can produce is 600 pounds.

This point would lie outside the production possibility frontier, at point G on the

diagram.

c. The opportunity cost of increasing output from 600 to 800 pounds of potatoes is

200 pounds of fish. If Atlantis increases output from 600 to 800 pounds of pota-

toes, it has to cut fish production from 500 pounds to 300 pounds, that is, by 200

pounds.

d. The opportunity cost of increasing output from 200 to 400 pounds of potatoes is

50 pounds of fish. If Atlantis increases output from 200 to 400 pounds of pota-

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