Prof. Gustavo Indart Department of Economics University of Toronto

ECO 100Y INTRODUCTION TO ECONOMICS

Problem Set 1

1. Labour is the only resource in an economy with the following maximum production

possibilities. (The graph is drawn as a curve rather than points under the assumption that opportunity cost is constant between options)

Option Clothes Food (Tons) (Tons) 1 50 0 2 40 30 3 20 70 4 0 100

a) What is the opportunity cost of increasing Clothes production from 20 to 40 tons?

b) What is the opportunity cost of increasing Food output from 70 to 100 tons?

c) Is point D an output option for this economy? Explain your answer.

d) What does point B represent in terms of resources?

e) Is point C a greater output combination than A? Explain.

f) What change in the economy is necessary to produce 50 tons of Clothes and

50 tons of Food if the labour force remains unchanged? 2. The table below gives some production possibilities for a country producing only two

goods: raw material output (Qr) and manufacturing output (Qm). All resources are fully employed. Assume constant opportunity costs between these options.

Qr (units) 11 10 8.5 6 3 0 Qm (units) 0 2 4 6 8 8.5

a) Graph the production possibilities curve with Qr on the horizontal axis.

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b) What is the opportunity cost to the economy of increasing manufacturing output (Qm) from: (i) 0 to 2 units? (ii) 2 to 8 units?

c) Pick a point on your diagram to represent less than full employment of labour

force is employed (relax the full employment assumption).

d) Graph the effects of a technological improvement that increases productivity in the manufacturing sector only.

e) Starting from your original graph, illustrate the effects of a contraction in the

labour force (e.g., emigration) with no technological change in either the raw material or manufacturing sector.

f) The PPC is typically drawn concave to the origin. What would be the

assumption underlying a PPC which is a straight line?

g) What is the difference between the resource cost of a commodity and the opportunity cost of a commodity?

3. The following table gives the production possibilities for an economy with full

employment of its resources, land, labour, and capital.

Option A B C D E F Steel (thousand tons) 100 90 70 50 25 0 Bread (million loaves) 0 60 120 160 180 200

a) What is the opportunity cost of increasing bread output from 60 to 120 million

loaves?

b) What is the opportunity cost per unit of raising steel output from 50 to 70 thousand tons?

c) What is the opportunity cost of increasing bread output from 169 to 170 million

loaves if opportunity cost is constant within this option?

d) What are the intercepts on the vertical (Steel) and horizontal (Bread) axes for the Production Possibilities curve that results if technological change increases Steel output by 50% and Bread output by 25% with no change in resources.

e) What is the effect on the Production Possibilities curve if gross investment is

greater than depreciation? 4. Albert: In the last few years there has been dramatic progress in agriculture. New

techniques and equipment have brought large increases in productivity.

Basil: Agricultural output, however, has hardly increased at all. It is non-agricultural output that has increased even though there has been relatively little technological progress in non-agricultural industries.

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Assuming that both Alberts and Basils facts are right, and that there is full employment: can you reconcile their statements? Portray your explanation on a production possibility curve, with agricultural output on the horizontal axis and non-agricultural output on the vertical axis.

5. Consider the following Production Possibilities Curve

Option A B C D E F G Capital Goods (Units) 30 28 25 20 15 10 0 Consumer Goods (Units) 0 10 19 25 30 35 40

a) What is the opportunity cost of adding the 30th unit of consumer goods?

b) What is the opportunity cost of increasing capital goods output from 25 to 30

units?

c) What is the opportunity cost of increasing output from 15 capital goods and 25 consumer goods to 20 capital goods and 25 consumer goods?

d) Opportunity cost is constant between which options?

e) Draw the production possibility curve that results from technological change that

increases capital goods production by 33% without affecting consumer goods output.

f) Draw a curve on the diagram representing the production possibility curve

following a war that destroys half the country's land, labour, and capital. Label this curve W.

g) Suppose depreciation is 15 units of Capital. Will the Production Possibilities

curve be smaller, unchanged, or greater in the next time period if the option chosen is i) C? ii) F? ii) E?

6. Suppose that Labour is Canada's only resource and that one unit of Labour can

produce either 2 units of Housing or 5 units of Food.

a) Draw Canada's Production Possibility Curve (PPC0) if Canada has 50 units of Labour. Put Housing on the vertical axis.

b) Now draw in your diagram the Production Possibilities Curve that would result if

technological change doubled only the Housing output of a unit of Labour.

c) Using any point (Q0) on your original PPC0 curve as a reference, alter your diagram in part b) to demonstrate how the output of Housing chosen by society

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could decline even if there was full employment and a technological doubling of Housing output per labour unit.

d) What would be the effect on opportunity cost if the amount of output per unit of

Labour doubled for both Housing and Food? 7. The production possibility curve for a country producing Food and Lumber is

F = 1800 3L.

a) What is the maximum amount of food that this country can produce?

b) What is the maximum amount of lumber that this country can produce?

c) What is the opportunity cost of increasing lumber production from 500 to 600 units? What is the opportunity per unit of raising food production from 200 to 201 units?

d) Suppose that the economy is presently producing 400 units of lumber and 400

units of food. What is the opportunity cost of producing 600 units of food and 400 units of lumber? What is the opportunity cost, relative to 400L and 400F, of producing 700 units of food and 400 units of lumber?

e) Suppose that this country has 300 units of a homogeneous resource (comprised

of capital, labour, and land). What is the output of lumber per unit of resource? What is the output of food per unit of resource?

f) Suppose that the country would like to produce 600 units of lumber and 600 units

of food. If there is no technological change, what is the minimum amount of resources needed to produce this output?

g) Suppose that technological change increases the output of food per resource by

50%. Sketch the production possibility curve. What is the equation for the production possibilities curve?

8. Assume that there are only three goods available in an economy. They are food,

shelter, and clothing. An average family buys 10 units of food, 2 units of shelter, and 1 unit of clothing. The prices in year 1, the base year, are $20 per unit of food, $400 per unit of shelter, and $40 per unit of clothing.

a) Now assume that in year 2 prices change so that food now costs $21, shelter

costs $440 and clothing costs $38. Calculate the consumer price index for year 2. What is the rate of inflation in year 2?

b) Now assume that in year 3 prices change again so that food now costs $22,

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shelter costs $429 and clothing costs $39. Calculate the consumer price index for year 3. What is the rate of inflation in year 3?