Reference no: EM131052403

Assignment 1

Notice:

- You are encouraged to work in a team of 8 people or less. Team-work skills are among important skills that you should acquire. Make sure the full names and student numbers of all the group members appear on the first page of the single copy that you submit for the team.

- Answer all the questions and show all your work.

- Make sure you staple together all the pages you hand-in.

- The assignment is due during the first 10 minutes of the class.

1. In an economy there are only two consumer goods: Gizmos and Widgets. Only labour is required to produce both goods, and the economy's labour force is fixed at 120 workers. The table below indicates the daily outputs of Gizmos and Widgets that can be produced with various quantities of labour.

Number of Workers	Daily Gizmos Production	Number of Workers	Daily Widgets Production
0	0	0	0
30	15	30	150
50	30	50	300
70	40	70	400
90	45	90	450
120	47.5	120	475

a. Draw the Production Possibility Boundary (PPB) for this economy using a gird with Widgets on the vertical access, assuming full employment in this economy. (Note: read the table carefully as the sorting is different from what you have seen before.)

b. What is the opportunity cost of producing the first 15 Gizmos? What is the opportunity cost of producing the next 15 Gizmos (i.e., from 15 to 30)? What happens to the opportunity cost of Gizmos as their productions is continuously increased?

c. Suppose that actual production levels for a given period were 15 Gizmos and 150 Widgets. What can you infer from this information?

d. Continuing from part (c), what is the opportunity cost of moving from the production combination of "15 Gizmos and 150 Widgets" to "15 Gizmos and 450 Widgets"? [Hint: think twice, the answer might not be as straight forward as it may seem at first!]

e. Suppose a central planner in this economy were to call for an output combination of 25 Gizmos and 450 Widgets. Is this plan attainable? Explain.

f. A new technology is developed in Gizmos production, so that each worker can now produce double the daily amount indicated in the schedule. What happens to the PPB? Draw the new boundary on the grid. Can the planner's output combination in (e) be met now?

2. An economy's production possibilities boundary is given by the mathematical expression 45 = A + 5B, where A is the quantity of good A and B is the quantity of good B.

a. If all resources in the economy where allocated to producing good A, what is the maximum level of production for this good? What is the maximum level of production for good B?

b. Draw the PBB on a grid putting A on the vertical axis.

c. Suppose that the production of B is increased from 3 to 5 units and that the economy is producing at a point on the production possibility boundary. What is the associated opportunity cost per unit of good B? What is the opportunity cost per unit of good B if the production of this good were increased from 5 to 7?

d. In what way is this PBB different from that in the previous exercise?

e. In what way does the combination of 30 units of good A and 7 units of good B represent the problem of scarcity?

3. The following table presents a decade's data on three components of a typical household's total expenses: education, housing, and food.

Year	Education	Housing	Food
1994	$13,740	$17,100	$16,600
1995	$15,180	$19,100	$17,600
1996	$16,380	$20,500	$20,000
1997	$17,700	$21,920	$22,500
1998	$18,940	$23,520	$24,000
1999	$20,260	$24,620	$25,200
2000	$22,280	$24,620	$26,000
2001	$24,510	$25,820	$26,600
2002	$29,300	$26,720	$26,700
2003	$32,230	$26,720	$27,600

a. Using year 1994 as the base year, construct individual indices for each of the three expense items.

b. Which of these three items increased the most in percentage terms for the period 1994 - 1995 and by how much? How about over the entire decade (1994 - 2003)?

c. What was the percentage increase in Housing expenses between 1997 and 1998?

4. Suppose that an economist hypothesizes that the annual quantity demanded of a specific computer brand (QD) is determined by the price of the computer (P) and the average income of consumers (Y) according to QD  = Y - 3P.

a. Which of these variables are endogenous and which are exogenous if we were interested in constructing a theory that explains the determination of quantity demanded with emphasis on the effect of price?

b. What does the negative sign before the tem 3P imply about the relationship between QD and P? What does the implicit positive sign before the term Y tell you about the relationship between income and quantity demanded?

c. Suppose for the moment that average income is given and equals $6,000. Rewrite the demand relationship by inserting this value into the given expression above.

d. Assuming that average income equals $6,000, calculate the values of QD when P = 0, P = $500, P = $1,000, and P = $2,000.

e. Put the relationship between P and QD (assuming Y = $6,000) on the grid, putting P on the vertical axis. Indicate the intercept values (X-intercept and Y-intercept) on each axis.

f. Assuming Y = $6,000, calculate the change in the quantity demanded when the price increases from $1,000 to 2,000. Do the same for a price increase from $500 to $1,000 and from $500 to $2,000. Call the change in the quantity demanded ????? and the change in the price ???. (? means "change in.")

g. Calculate the slope of the relationship graphed in previous part.

h. Now suppose that evidence indicates that the average income of consumers has changed to $9,000. Plot the new relationship between P and QD and determine the slope and intercepts. How does this change affect the graph compared to the previous one? Calculate the quantity demanded for the list of prices given in part (d) and compare these with those in part (d). Do you see a general pattern? Fill the blank in the following sentence: "All else equal, at any given price, higher income results in     quantity demanded." [Notice: this is how we analyse the effect of changes in exogenous variables.]

5. Consider two equations describing the relationship between three variables X, Y1, and Y2: X = a + b Y1,    (1) X = c - d Y2, (2) where a, b, c, and d, are positive, known constants (numbers). The objective is to find values of X, Y1, and Y2 for which both equations are satisfied and as well Y1 = Y2.

a. How many unknown variables are there? Clearly identify them. How many equations are there? Clearly identify them. Note that there should be as many equations as unknown variables. When this is the case, a unique solution exists. (Try to convince yourself that having only (1) and (2) makes it impossible to solve for the unknown variables, by equating X from (1) to X from (2) and trying to solve for Y1  and Y2.)

b. Replace both sides of the third equation (which one is it?) using expressions (1) and (2) to solve for X.

c. After solving for X, find the values of Y1  and Y2 and verify whether the third equation is satisfied.

d. Now, rename Y1 as QS  representing quantity supplied, replace a with 200, replace b with 2, rename Y2 as QD representing quantity supplied, replace c with 400, replace d with 3, and rename X as P representing price. This gives you a system of supply and demand for a good. Re-write expressions (1) and (2) using this information. How many unknown variables and how many equations do you have?

e. To find the equilibrium and solve for equilibrium values of QD, QS, and P, what other condition do we need? [Hint: Think about our discussion in class and the fill the blank here to find out what other condition you might need: "If quantity demanded is more than quantity supplied, the price will            . If quantity demanded is less than quantity supplied, then price will                  . So, price will not change only if quantity demanded              quantity supplied. This is how we define equilibrium: a condition under which variables in the model remain stable and do not change. We call this additional equation market-clearing condition."]

f. Given the system of supply and demand and the market-clearing condition, solve for equilibrium values of QD, QS, and P.

g. Show the supply and demand curves on a grid putting price on the vertical axis and clearly identify the equilibrium price and quantity.

h. What is the quantity supplied and demanded at P = 290? Excess supply or excess demand, which one exists at this price and what is the size of it? How is expected to affect the price? How is the induced change in price expected to affect quantities demanded and supplied?

i. What is the quantity supplied and demanded at P = 220? Excess supply or excess demand, which one exists at this price and what is the size of it? What are the expected impacts on the variables of the model?

j. Based on the concepts of excess supply and excess demand and how they put upward or downward pressures on price argue why any price other than the one you identified in (f) cannot establish equilibrium.

6. Explain the following concepts in detail (must be in English, complemented with any formulas or diagrams or anything extra that you might necessary to complete your description):

a. Nominal and Real National Income

b. Actual and Potential total output

c. Hypothesis

d. Normative and positive statements

e. Unemployment rate

f. Frictional, Structural, and Cyclical unemployment

g. CPI

h. Percentage change in a variable

i. Change in a variable

j. Slope

k. Opportunity cost

l. Productivity

m. Market economy

n. Correlation vs. causation

o. Macroeconomics

p. Business cycle

q. Recessionary gap and inflationary gap

r. Labour force

s. Exchange rate, depreciation and appreciation

t. Inflation and price level

u. Value added

v. GDP and GNP

w. Economic goods and bads

x. GDP deflator

y. GDP from the income side

z. GDP from the expenditure side