1. A shipwreck has stranded two people, Alice and Bob, on a desert island. This island’s food supply comes from its abundant coconut trees and the plentiful fishes that swim in the waters near the beautiful, white sand beaches that line its coast. Alice is a mediocre swimmer, but a brilliant climber, meaning that it takes her two hours to catch one fish, but only half an hour to gather one coconut. Bob is a good swimmer and a decent climber. It takes him one hour to catch a fish and one hour to gather a coconut. Although this island is near the equator and has many hours of sunlight, both Alice and Bob are exhausted after only eight hours of foraging each day.
a. How much of each good would be produced in one day if Alice and Bob each split their time evenly between both activities?
b. How much of each good would be produced in one day if Alice only fished and Bob only gathered coconuts.
c. What would the daily production of goods be if Bob only fished and Alice only gathered coconuts?
d. Who has the absolute advantage in producing coconuts? Who has the comparative advantage in catching fish?
e. Assuming that Alice and Bob prefer to eat some mix of coconuts and fish, does it make sense for them to specialize in production? Who should specialize in the production of which good?
f. If Alice had a nasty fall that caused her to develop a fear of heights, reducing her coconut production rate to two hours per coconut, who would have the absolute advantage in each good? Who would have the comparative advantage? Would gains from trade still be possible?
2. Describe the effects of the following scenarios on the price and quantity of silk scarves in a market using supply-and-demand diagrams.
a. A disease is killing the silkworm population.
b. A very unpopular celebrity starts wearing silk scarves all the time, causing many to change their habits to avoid being compared to her.
c. Changes in the climate reduce temperature extremes, making winters less cold and summers less hot.
d. A new method of cheaply synthesizing silk is discovered.
4. For each of the following pairs of goods indicate which one will be more elastic. Briefly explain why.
a. Potatoes or Caviar.
b. Cadillac Escalades or Automobiles.
c. Pop music mp3s or symphonic death metal mp3s.
5. The government of the isolated nation of Tinyland believes that tobacco cigarettes are causing public health problems that need to be addressed. Smoking is highly addictive, meaning that consumers do not change their behavior very much in response to price differences. The farmers of Tinyland are blessed with rich soil that can easily grow any number of crops, including tobacco. Three different groups have proposals designed to address the problems arising from smoking. Analyze the effect each proposal would have on the cigarette market, focusing especially on how much smoking would be reduced and who would lose or benefit from the program.
a. The central government proposes a tax on cigarettes in order to give smokers an incentive to stop smoking.
b. A group of concerned citizens believe that creating a minimum price above the current market price might discourage smokers from smoking.
c. A lobby representing smokers argues that forcing producers to sell at much lower prices would pressure tobacco growers to stop producing so many cigarettes.
6. The local government is planning two new taxes on services: one on tourism services (such as travel agencies), and the other on healthcare.
a. Which of the two taxes is likely to cause more deadweight loss? Why?
b. Which worker is more likely to lose his or her job because of such a tax: a nurse or a travel agent? Explain.
c. If the government wanted to raise tax revenues in the most efficient way possible, which of the two taxes would it be more likely to abandon? Why?
d. Is the most efficient tax the best tax for residents of this locality? Why or why not? Be sure to explain how you define what a good tax is.
7. Over the past few years there has been a dramatic increase in the demand for coffee.
a. Does this make people who buy coffee better off or worse off? Explain, using the concept of consumer surplus.
b. Is the move beneficial or harmful to coffee sellers? How do you know? Explain, using the concept of producer surplus.
c. Is the overall economic wellbeing generated by the market greater or less than it was before the new firms entered the market? Explain.
8. Recently residents of the nation of Autarkia have noticed that the price of woolen goods has increased dramatically, even to the point where very few Autarkians buy anything made of wool. At the same time, many Autarkians have quit their other jobs in order to raise sheep to produce wool. What change in government policy could explain this?
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