1.

Four Fundamental Questions of Economics

What to produce?

 This question addresses the types of goods and services an

economy should produce based on societal needs and available
resources. Different economic systems prioritize different products,
reflecting societal values and goals.

How to produce?

 This question considers the methods and resources used to produce

goods, focusing on choices around technology, labor, and
environmental impacts. It asks whether goods should be produced
in a labor-intensive or capital-intensive way and examines
environmental effects of production methods.

For whom to produce?

 This question involves the allocation of output, determining how

goods and services are distributed among society’s members. It is
influenced by factors such as income distribution, wealth, and
access, often shaped by economic policies.

Is indefinite economic growth sustainable within ecological

limits?

 From an ecological economics perspective, this added question

challenges the notion of continuous economic growth in a world with
finite resources. It emphasizes sustainability and whether the
economy, as an open system, can grow indefinitely within the
biosphere, a closed system.

2.

Answer: True

3.

Answer: c The English Crown requiring that all of its citizens who go out
on the streets on a Sunday must wear caps made of English wool

4 a.

Assumptions:
  The only input is cell phones per worker.

 Output per worker is measured by the number of consultations

completed.

Key Points:

 First Point: Represents the output per worker with the first cell
phone.

 Second Point: Represents the output per worker with a second cell
phone.

The production function should have a concave shape due to

diminishing marginal returns. This means that while each additional
cell phone increases output, the increase becomes smaller with each
added phone.

 The curve shows diminishing marginal returns, meaning that

while each additional cell phone per worker increases output, the
increase is less significant with each additional unit.

 Point (1, 20) represents output per worker with the first cell phone,
and Point (2, 35) shows output with a second phone, reflecting the
smaller increase due to diminishing returns.

4b: Explanation:

1. Capital Deepening and Diminishing Returns:

o Capital deepening (providing more cell phones per worker)

increases productivity, but due to diminishing returns, each
 additional input yields a smaller increase in output per worker.
Therefore, relying only on capital deepening limits the
potential for sustained growth.

2. Role of Technological Advancements:

o To achieve continuous 3% growth, productivity improvements

beyond just increasing inputs are needed. Innovations in
technology or processes can shift the production function
upward, enabling each worker to produce more consultations
even without additional cell phones.

In the diagram, sustained growth would appear as an upward shift

in the entire production curve, indicating that productivity has
improved due to factors beyond just additional inputs.

5. To calculate the opportunity cost, we add up all costs associated with

choosing to attend college over working full-time.

1. Foregone Income:

o If you were working full-time, you would earn $40,000 per

year. By attending college, you give up this amount, which
represents an opportunity cost.

2. Part-Time Earnings as a Student:

o While attending college, you earn $10,000 as a part-time

worker. Since this amount partially offsets the $40,000 you
would have earned, we calculate the difference.

o Foregone income adjusted for part-time earnings =

$40,000 - $10,000 = $30,000

3. Direct Costs of College (Tuition, Fees, Books):

o This is the actual expenditure for attending college, totalling

$27,000 per year.

4. Room and Board Costs:

o Since these costs ($13,500) would occur whether you are at

college or not, they are not included in the opportunity cost
calculation. Opportunity cost only considers the additional or
foregone benefits directly related to the choice.

Calculation:
Opportunity Cost = Adjusted Foregone Income + Direct College Costs
Opportunity Cost = $30,000 + $27,000
Opportunity Cost = $57,000

Thus, the opportunity cost of attending UVA for one year is

$57,000.

6a. Calculate the Slope of the Supply Curve

The slope of the supply curve is calculated by using the formula:

Change in Price
Slope=
Change in Quantity Supplied

We can use two points on the supply curve, say:

 Point 1: (Qs =1 , P=10)

 Point 2: (Qs =2 , P=20)

Using these points:

20−10 10
Slope= = =10
2−1 1
So, the slope of the supply curve is 10.

6b. Situation at a Price of $10

 Quantity Demanded (Q^D) is 5.

 Quantity Supplied (Q^S) is 1.

Since Q^D > Q^S at this price, there is excess demand in the market.

Answer: 3. Excess Demand

7a. Absolute Advantage: The individual who can produce more of a

good or service in the same amount of time has an absolute advantage.

1. Preparing Food:

o Sue can prepare 40 meals per hour.

o Tim can prepare 20 meals per hour.

o Sue has the absolute advantage in preparing food, as she can

prepare more meals in an hour than Tim.
 2. Mixing Drinks:

o Sue can mix 40 drinks per hour.

o Tim can mix 30 drinks per hour.

o Sue also has the absolute advantage in mixing drinks, as she

can mix more drinks per hour than Tim.

7b. Opportunity Cost: The opportunity cost of one activity is what must
be given up to do another.

1. Sue's Opportunity Cost of Mixing Drinks:

o If Sue spends one hour mixing 40 drinks, she forgoes

preparing 40 meals.
40 meals
o Opportunity cost of 1 drink = =1meal per drink.
40 drinks
2. Tim's Opportunity Cost of Mixing Drinks:

o If Tim spends one hour mixing 30 drinks, he forgoes preparing

20 meals.
20 meals
o Opportunity cost of 1 drink = ≈0.67 meals per drink.
30 drinks
Since Tim’s opportunity cost of mixing drinks (0.67 meals) is lower
than Sue’s opportunity cost (1 meal), Tim has the comparative
advantage in mixing drinks.

Specialization Recommendation

Even though Sue has an absolute advantage in both tasks, Tim should
specialize in mixing drinks because he has a comparative advantage
in that task. This allows them to allocate their time and resources more
efficiently, with Sue focusing on preparing food and Tim on mixing
drinks.

8. Analysis with Supply-Demand Diagram:

1. Initial Market Conditions:

o In a competitive market with many coffee suppliers, the

equilibrium price and quantity of brewed coffee is determined
by the interaction of supply and demand.
2. Impact of a Decline in Green Coffee Prices:

o As the price of green coffee (an input) decreases, the

production cost for each coffee shop falls.

o Lower input costs lead to an increase in the supply of

roasted coffee, shifting the supply curve for brewed coffee
to the right (from Supply1 to Supply2).

3. Effects on Equilibrium:

o The rightward shift in the supply curve results in a new

intersection with the demand curve, creating a lower
equilibrium price and a higher equilibrium quantity for brewed
coffee.

o The decrease in price encourages more consumers to

purchase coffee, while suppliers are willing to supply more
coffee at this new lower price.

4. Market Participant Behavior:

o Consumers benefit from the lower price and increase their

quantity demanded.

o Suppliers may see an increase in total sales volume, but the

individual profit per unit may decrease unless they can
achieve cost efficiencies
 Initial Equilibrium (E1): The original supply curve (Supply1)
intersects the demand curve at a higher price and lower
quantity.

New Equilibrium (E2): With the cost reduction in green

coffee, the supply curve shifts right (to Supply2), leading to a
lower equilibrium price and a higher equilibrium quantity.

9. Option (c): The rent control prevents the market signal from being
given that would otherwise suggest to real estate developers to build
more housing units.

10.

Answer: c. Increased discrimination in the primary market leads to

layoffs and wage declines in the secondary market, widening inequality
between the two sectors.

11.

Answer: d. All options are correct

12. part a

Initial Scenario:

 The initial exchange rate is ¥8 per USD, meaning each Dollar can
be exchanged for 8 Yuan.

 A decrease in the cost of Chinese labor lowers the prices of Chinese

goods, making them more attractive to U.S. consumers.

Increased Demand for Chinese Products:

 As U.S. consumers buy more Chinese goods, they need more Yuan
for transactions.

 This increased demand for Yuan means that U.S. consumers supply
more Dollars to obtain Yuan.

Effect on the US Dollar:

 With more Dollars supplied in exchange for Yuan, the value of the
Dollar ecreases (depreciates), while the Yuan appreciates.
  This effect can be shown as a rightward shift in the supply
curve for Dollars, leading to a lower e exchange rate for the Dollar
relative to the Yuan.

 Initial Equilibrium (E1): The original supply and demand curves

intersect at a higher exchange rate.
 New Equilibrium (E2): With increased U.S. demand for Yuan (and
thus a higher supply of Dollars), the supply curve for Dollars shifts
rightward, leading to a lower exchange rate. This reflects a
depreciation of the Dollar and an appreciation of the Yuan.

Part (b) Explanation: Chinese Authorities Maintaining the Peg

To maintain the pegged exchange rate of Y8 per USD, the Chinese

authorities could:

1. Increase Demand for Dollars: The Chinese central bank could

buy Dollars in exchange for Yuan, creating an upward shift in the
demand for Dollars. This action would offset the excess supply and
push the exchange rate back to the pegged rate of Y8 per Dollar.

2. Supply Yuan: By supplying more Yuan in exchange for Dollars, they

can increase the demand for Dollars, helping to maintain the desired
peg.

This intervention keeps the exchange rate stable, as desired by the

Chinese authorities.

13a Answer: True

Explanation:
The Dollar’s appreciation makes Mexican vacations cheaper for U.S.
tourists, but it may reduce demand from Mexican consumers whose
purchasing power declines. If reduced Mexican demand outweighs
increased U.S. demand, the demand curve shifts left

13b.Answer: False

Explanation:
Exchange rate changes do not impact the supply of U.S. vacations, so the
supply curve remains unchanged.

13c. Answer: False

Explanation:
Increased U.S. demand could be offset by decreased Mexican demand,
making a broad price increase in Mexico unlikely.

14.

Answer: b. The new minimum wage will result in layoffs

15.

Answer: d. All of the above