1) Opportunity cost is the best alternative use of a resource. It is what an economic agent is giving up when he chooses a particular option. If the individual decides to take the first job; he will earn $35,000 a year. The opportunity cost of taking this job is the next best offer that he could have taken up. Therefore, the opportunity cost of the first job is $23,000 a year. 2) The opportunity cost of painting a T-shirt for Beth is 1/2 a wall and the opportunity cost of painting a T-shirt for her brother is 2/1 or 2 walls. Therefore, Beth has a comparative advantage in painting T -shirts and should specialize in it. The opportunity cost of painting a wall for Beth is 2/1 = 2 T-shirts and the opportunity cost of painting a wall for her brother is 1/2 a T-shirt. Therefore, her brother has a comparative advantage in painting walls and should specialize in painting walls. 3) B 4) D 5) A 6) A 7) A negative marginal total cost implies that the decision maker is gaining from the switch between options. A positive marginal cost implies that the decision maker is losing from the switch between options. In this case, moving to Option B makes the decision maker better off, while moving away from it makes the decision maker worse off. Hence, Option B is better of the two. The underlying principal behind this decision is referred to as the Principal of Optimization at the Margin. 8) analysis is a cost-benefit analysis that compares the consequences of doing one step more of something. Hence, it is a cost-benefit calculation that studies the difference between a feasible alternative and the next feasible alternative. To arrive at the conclusion regarding optimum choice of apartment using marginal analysis, it is essential to calculate the marginal commuting cost and the marginal rent cost for movement between each set of alternatives. This is shown in the table below. Apartment Gasoline Consumption (gallons per Commuting cost Commuting Cost Rent Rent Cost Total Cost 1 5 25-1,100 - - 2 10 50 25 1,000-100 -75 3 15 75 25 960-40 -15 4 20 100 25 940-20 5 The marginal total cost of moving from Apartment 1 to Apartment 2 is -$75. This implies that the individual gains $75 if he moves from Apartment 1 to Apartment 2. This move is beneficial. The second movement from Apartment 2 to Apartment 3 has a marginal total cost of -$15. This implies that the individual gains $15 if he moves from Apartment 2 to Apartment 3. This move is beneficial too. The third move from Apartment 3 to Apartment 4 has a marginal total cost of $5. This implies that the individual loses $5 if he moves from Apartment 3 to Apartment 4. This move is not beneficial. Hence, from the above inferences it is clear that moving toward Apartment 3 is beneficial, whereas moving away from Apartment 3 is not. This implies Apartment 3 is the optimum choice for the individual. The principle used to arrive at the optimum choice is referred to as the Principal of Optimization at the Margin. It states that an optimal alternative has the property that moving to it makes the decision-maker better off and moving away from it makes the decision maker worse off. 9) B 10) D 11) D 14
12) a) In the figure below, the initial equilibrium is determined by the intersection of the supply curve, S1, and the demand curve, D1. The initial equilibrium price is P* and the equilibrium quantity is Q*. If the supply curve shifts to the left to S2 and the demand curve shifts to D2, the new equilibrium price is Pnew and the equilibrium quantity is Qnew. It is seen from the figure that at the new equilibrium, both the equilibrium price and quantity are higher than at the initial equilibrium. b) In the figure below, the initial equilibrium is determined by the intersection of the supply curve, S1, and the demand curve, D1. The initial equilibrium price is P* and the equilibrium quantity is Q*. If the supply and demand curves both shift to the right to S2 and D2, respectively, there is an increase in the equilibrium quantity of laptops but the equilibrium price remains unchanged. 15
c) In the following figure, the initial equilibrium is determined at the intersection of the supply curve, S1, and the demand curve, D1. The initial equilibrium price is P* and the equilibrium quantity is Q*. If the demand curve shifts right to D2, the supply curve remaining unchanged, the market reaches a new equilibrium at a higher price Pnew and a higher quantity, Qnew. 13) B 14) D 15) C 16) B 17) D 18) B 19) A 20) D 21) B 22) D 23) B 24) A 25) D 26) D 27) A 28) A 29) D 30) The difference between real GDP and nominal GDP is that real GDP measures the final value of a countryʹs output, using the prices in a base year, while nominal GDP measures the final value of a countryʹs output, using current market prices. 16
31) Consider an economy that produces only apples. If the price of apples in 2001 is $1 and the economy produces 10 apples, the nominal GDP of the economy is $10. Now, suppose in 2002, the price of apples doubles without any change in production. In this case, the nominal GDP of the economy in 2002 is $20. However, real GDP in both years is $10 if year 2001 is taken as the base year. So, according to real GDP, output has not changed between the two years. Hence, the real GDP, which accounts for inflation, is a more accurate measure of the level of production than nominal GDP. 32) i) Real GDP is the total value of a countryʹs output using base year prices. In this case, the base year is Year 1. Therefore, real GDP of Polonia in Year 2 is 120 $10 + 300 $12 = $1,200 + $3,600 = $4,800. ii) Poloniaʹs real GDP for Year 1 is 100 $10 + 250 $12 = $1,000 + $3,000 = $4,000 and for Year 2 is $4,800. The growth rate of Poloniaʹs GDP is ($4,800 - $4,000)/$4,000 = 0.2 or 20%. 33) The consumer price index for a particular year is calculated using the formula: CPI(Year 2) = (Cost of buying a particular basket of goods using Year 2 prices / Cost of buying the same basket of goods using Year 1 prices) 100 Cost of buying the goods in Year 2 = 10 $1.50 + 5 $2 + 4 $2.50 = $39.50. Cost of buying the goods in Year 1 = 10 $1.40 + 5 $1.80 + 4 $2 = $31. Therefore, the consumer price index for Year 2 is ($35/$31) 100 = 122.9 34) B 35) D 36) B 37) A 38) C 39) Unemployment rate in the country = (Labor force - employed workers)/labor force = (45,000-39,000)/45,000 = 13.33%. Labor force participation rate in the country = Labor force/potential adult workers = 45,000/60,000 = 75%. 40) D 41) D 42) B 43) A 44) C 45) B 46) A 47) A profit maximizing firm will pay a worker the value of the workerʹs marginal product, which is defined as the incremental income that this worker will generate for the firm. Value of marginal product of the worker = 8 $5 = $40. Hence, the maximum wage that should be paid to the worker is $40. 48) Any change that affects the entire schedule relating the quantity of labor and the value of marginal product of labor will shift the labor demand curve. Factors that can cause the labor demand curve to shift rightward are: a) Increase in output prices: If the price of the output the labor is used to produce increases, the labor demand curve shifts rightward. b) Technology and productivity: If technological progress increases labor productivity, the demand schedule for labor shifts to the right. c) Falling input prices: If there is a fall in the price of inputs that are combined with labor to produce output, the labor demand curve shifts rightward. 49) C 50) B 51) C 52) D 53) A 17
54) B 55) B 56) The quantity theory of money implies that inflation is equal to the gap between the growth rate of money supply and real GDP. In this case, inflation rate = growth rate of money supply - growth rate of real GDP = 8% - 6% = 2%. 57) D 58) C 59) D 60) B 61) C 62) a. If there is an increase in the real interest rate, there will be an upward movement along the credit demand curve of the software manufacturer. b. If they plan to expand production in near future, the credit demand curve of the software firm is likely to shift to the right. 63) a. Everything else remaining unchanged, if there is a decrease in the real interest rate, there will be a downward movement along the credit supply curve of households. b. Everything else remaining unchanged, if households expect a recession in near future, they will tend to save more today. This will cause the credit supply curve of households to shift to the right. 64) D 65) A 66) C 67) D 68) C 69) D 70) D 71) B 72) C 73) D 18