Principles of Macroeconomics

Chapter 3 Problems & Applications

(a)

The production opportunities for Maria:

Subject # of pages in 1 # of pages in 5

hour hours
Economics 20 100

Sociology 50 250

(b) Maria’s opportunity cost of reading 1 page of sociology = 20/50 pages of economics

So, 100 pages of sociology = (20/50) x 100 = 40 pages of economics.

 (a) England can produce one scone in 0.02 hours which is less than 0.025 hours of Scottish workers.
England has absolute advantage in producing scones. Scottish workers take only 0.5 hours to
produce one sweater which is less than 1 hour taken by the English workers. Scotland has
absolute advantage in producing sweaters.

Opportunity cost of scones and sweaters is:

Cost of
1 scone 1 sweater

1/50 = 0.02 sweater 50 scones

2/40 = 0.05 sweater 40/2 = 20 scones

England has comparative advantage in making scones as their opportunity cost is 0.02 sweaters which is
less than Scotland. Scotland has comparative advantage in making sweaters since their opportunity cost
is 20 scones, less than England’s opportunity cost of 50 scones.

(b) Scotland has comparative advantage with sweaters. Hence, Scotland should trade sweaters with

England in order to benefit from the trade. They both will gain from trade as long as the opportunity
cost of sweaters for Scotland is less than 50 and more than 20 scones.

(c) If Scottish workers produces only 1 sweater per hour, the opportunity cost per sweater = 40/1 =

40 scones. Hence, Scotland will still gain from trade because they have comparative advantage with an
opportunity cost of 40 scones which is still less than the opportunity cost of 50 scones per sweater for
England.
 Principles of Macroeconomics

Chapter 4 Problems & Applications

The statement is false. The increase in demand for notebooks results in an increased quantity supplied.

Thus, when there is rise in the demand, the quantity supplied will also rise.
The only way the above asked statement would be true is if the supply curve were a vertical line.

(a) When people decide to have more children, it leads to increase in population. An increase in

population would mean increase in demand of minivans. Increase in demand means increase in price.

An increase in demand shifts the demand curve to the right. The new equilibrium is at E2. The new price
increases from P1 to P2. The quantity demanded increases from Q1 to Q2.

(b) Since steel is a raw material for minivan production, a strike by steel works will increase the
price of steel and increase the cost of production of vans. The demand will not be affected but supply
would reduce as a result of high cost of production which leads to an increase in price of minivans.

A decrease in supply is from S1 to S2, the price increases from P1 to P2 and the quantity decreases from
Q1 to Q2.

(c) The new machinery is an improvement in technology. This reduces the firm’s costs which will

result in an increase in supply. The demand stays unaffected, the price declines and quantity sold
increases.

The increase in supply is to the right. The quantity supplied increases from Q1 to Q2. The price decreases
from P1 to P2.

(d) The sport utility vehicle is a substitute for minivan. When the price of SUV rises, the demand for

minivans will increase, causing the price of minivans to increase.

The increase in demand is to the right. The quantity increases from Q1 to Q2. The price increases from P1
to P2.

(e) A stock market crash lowers people’s wealth and their spending reduces. This leads to a fall in
demand of minivans. With the supply being constant, a fall in demand will lead to a fall in price.

The demand curve shifts left. Quantity increases from Q1 to Q2 and price decreases from P1 to P2.

(a) DVDs and TV screens are compliments.

DVDs and movie tickets are substitutes.
TV screens and movie tickets are substitutes.

(b) As the cost of manufacturing TV screens reduces, the supply of TV screens will increase. Which

makes the price fall as demand remains same.

The supply curve shifts to the right. The quantity increases and price reduces.

(c) TV screens and DVDs are compliments. The fall in price of TV screens will lead to an increase in
demand of DVDs which causes the price of DVDs to rise. TV screens and movie tickets are
substitutes. As the price of TV screen reduces, the demand for movie tickets decreases which
causes its price to fall.

1. TV screens and DVDs

 2. TV screens and movie tickets

The demand for babysitters increases in 2020, since 5 year old needs a baby sitter. Hence, the demand
curve for babysitters shifts right.

The supply for babysitters increases in 2030, since a 15 year old can be a babysitter. The supply curve for
babysitters shifts right.

Quantity demanded QD = 1600 – 300P

Quantity supplied QS = 1400 + 700P

Market is in equilibrium when QD = QS. Setting both equations equal and using algebra,

1600 – 300P = 1400 + 700P

700P + 300P = 1600 – 1400

1000p = 200
p= 0.2 = $.020

Verifying answer:

QD = 1600 – 300P = 1600 – 300(0.20) = 1540

QS = 1400 + 700P = 1400 + 700(0.20) = 1540

Therefore, equilibrium price is [$0.20] and equilibrium quantity is [1540] bars.

 Principles of Macroeconomics

Chapter 6 Problems & Applications

The price ceiling of $40 is a binding constraint on the market. At this price, the number of concert tickets
demanded exceeds the quantity supplied. There will be a shortage of tickets. So, the policy decreases
the number of people who attend classical music concerts because the quantity supplied is lower
because of the lower price.

(a) The equilibrium price is where QD = QS. They are equal at quantity of 6 million Frisbees with the

equilibrium price of $8.

(b) Imposing a price floor of $2, above the equilibrium price of $8 makes the minimum price to be

at $10 per Frisbee. At this price, 12 million Frisbees are supplied with only 2 million Frisbees demanded.
Thus, there will be a surplus of 10 million Frisbees.
 (c) The price ceiling is the maximum market price, which is 10 – 1 = $9. However, the price ceiling is

also above the equilibrium price of $8, so the price ceiling has no effect. Frisbees demanded are 4
million and supplied are 9 million. Hence, there will also be a surplus in this case of 5 million Frisbees
since only 4 million Frisbees are sold.

Luxury cars have an elastic demand with an inelastic supply. Imposing $500 tax on luxury cars would be

The price paid by the consumers increase from P1 to P2. This increase is less than $500 of tax from P3 to
P2. Since there is inelastic supply, more of the tax will be on firms than consumers who have elastic
demand. Therefore, the increase in price is less than $500.

(a) The effect of $0.50 per cone subsidy on the demand curve for ice-cream cones
There is an upward shift in the demand curve from D1 to D2. The effective price paid by the consumers is
at P3. The effective price received by the sellers is at P2. The amount of subsidy P3P2 = $05.50 and the
quantity of cones sold increases from Q1 to Q2.

(b) The consumers will gain from this policy since they have to pay P3 instead of P2. With a gain of

$0.50 per cone, firms will also gain because they are selling more quantity at increased price. The
government loses $0.50 for every cone sold by the firm or purchased by the consumer.