Chapter 2

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FT3b: Katie works at a customer service center and every hour she has a
choice between two activities: answering 200 telephone calls per hour or
responding to 400 emails per hour. What is the opportunity cost of
responding to 400 phone calls?

A: 800 emails.

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FT5a. Consider the productivity table below: Which region has an absolute
advantage at making high-quality cars? And low-quality cars?

A: North has an absolute advantage at both high-quality and low-quality cars.

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FT5b. Using the information in the productivity table above, estimate the
opportunity cost of making high- or low-quality cars in the North and in the
South. Which region has a comparative advantage (i.e., lowest opportunity
cost) for manufacturing high-quality cars? For low-quality cars?

A: After calculating opportunity costs horizontally within countries, compare

them vertically across countries to determine who has a comparative
advantage. North’s comparative advantage is high-quality cars (lower
opportunity cost of making high-quality cars). South’s comparative advantage
is low-quality cars (lower opportunity cost of making low-quality cars).
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FT5c. There are 1 million hours of labor available for making cars in the North,
and another 1 million hours of labor available for making cars in the South. In a
no-trade world, let’s assume that two-thirds of the auto industry labor in each
region is used to make high-quality cars and one-third is used to make low-
quality cars. Solve for how many of each kind of car will be produced in North
and South, and add up to determine total global output of each type of car.
(Why will both kinds of cars be made? Because the low-quality cars will be less
expensive.)

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FT5d. Now, allow specialization. If each region completely specializes in the type of
car in which it holds the comparative advantage, what will global output of high-
quality cars be? Of low-quality cars? In the table below, report your answers. Is
global output in each kind of car higher than before? (We’ll solve a problem with
the final step of trade in the Thinking and Problem Solving section.)

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PS1: Fit each of the following examples into one of these reasons for trade:
I. Division of knowledge
II. Comparative advantage

a. Two recently abandoned cats, Bingo and Tuppy, need to quickly learn how to catch mice in
order to survive. If they also remain well groomed, they stand a better chance of surviving:
Good grooming reduces the risk of disease and parasites. Each cat could go it alone, focusing
almost exclusively on learning to catch mice. The alternative would be for Bingo to specialize
in learning how to groom well and for Tuppy to specialize in learning how to catch mice
well.

b. Former President Bill Clinton, a graduate of Yale Law School, hires attorneys who are less
skilled than himself to do routine legal work.

A:
a. Division of knowledge
b. Comparative advantage
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PS2: In each of the cases below, who has the absolute advantage at each task, and who has the
comparative advantage?

a. In 30 minutes, Kana can either make miso soup or she can clean the kitchen. In 15 minutes,
Mitchell can make miso soup; it takes Mitchell an hour to clean the kitchen.

A: Mitchell’s absolute and comparative advantages are at miso; Kana’s absolute and comparative
advantages are at cleaning.

b. In one hour, Ethan can bake 20 cookies or lay the drywall for two rooms. In one hour, Sienna can
bake 100 cookies or lay the drywall for three rooms.

A: Sienna has an absolute advantage at both, but her comparative advantage is at baking cookies.
Ethan’s comparative advantage is at laying drywall. Opp cost of baking 1 Opp Cost of laying
Cookie drywall for 1 room
Ethan 1/10 room 10 cookies
Sienna 3/100 room 33.333 cookies
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c. Kara can build two glass sculptures per day or she can design two full-page newspaper
advertisements per day. Sara can build one glass sculpture per day or design four full-page
newspaper ads per day.

A: Kara’s absolute and comparative advantages are at sculpture, while Sara’s absolute and
comparative advantages are at newspaper ad design. Opp cost of building 1 Opp cost of designing 1
glass sculpture page of advertisement
Kara 1 newspaper ad 1 glass sculpture
Sara 4 newspaper ad ¼ glass sculpture

d. Data can write 12 excellent poems per day or solve 100 difficult physics problems per day. Riker
can write one excellent poem per day or solve 0.5 difficult physics problems per day.

A: Data has an absolute advantage at both, but Riker has a comparative advantage at writing poetry.
Opp cost of writing Opp Cost of solving 1
1 poem difficult physics problem
Data 8.33 physics problem 0.12 poem
Riker 0.5 physics problem 2 poems 9
PS3: The federal education reform law known as No Child Left Behind requires every state to
create standardized tests that measure whether students have mastered key subjects. Since the
same test is given to all students in the same grade in the state, this encourages all schools within a
state to cover the same material. According to the division of knowledge model, what are the costs
of this approach?

A: The cost is that with everyone knowing the same thing, our “hive mind,” our social
knowledge, is less powerful than it could be. For instance, some parts of a state might emphasize
statistics courses in high school while other parts might emphasize geometry and other parts might
emphasize number theory. Each could be useful at a particular place and time, but few students
would have the time to master all three fields. But it’s not necessary for everyone to master all
three: It’s enough to have a few (thousand) people who master each field, just in case a need arises.
Undergraduate university education is more specialized than high school, graduate university
education is more specialized yet. Indeed, the ideal of a graduate education is that at some point
the PhD candidate knows something that no one else in the world knows!

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PS4: In this chapter, we’ve often emphasized how specialization and exchange
can create more output. But sometimes the output from voluntary exchange is
difficult to measure and doesn’t show up in GDP statistics. In each of the
following cases, explain how the two parties involved might be able to make
themselves both better off just by making a voluntary exchange.

a. Alan received two copies of Gears of War as birthday gifts. Burton received two
copies of Halo as birthday gifts.

A: Alan could give one of his copies of Gears to Burton, who could offer one of
his copies of Halo.

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b. Jeb has a free subscription to Field and Stream but isn’t interested in hunting.
George has a free subscription to the Miami Herald but isn’t all that interested
in Florida news.

A: They could swap free subscriptions, and both be better off, especially if
both men have the last name Bush. At the very least, both parties are no worse
off after the exchange.

c. Pat has a lot of love to give, but it is worthless unless received by another.
Terry is in the same sad situation.

A: If they offer love to each other, both will be better off at no cost: A classic
positive-sum game.

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Chapter 3

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FT2: When will people search harder for substitutes for oil: When the price of
oil is high or when the price of oil is low?

A: When the price of oil is high, people will search harder for substitutes.

FT3: Your roommate just bought an iPod for $200. She would have been willing
to pay $500 for a machine that could store and replay that much music. How
much consumer surplus does your roommate enjoy from the iPod?

A: She enjoys $300 of consumer surplus from the iPod. (Willingness to pay
minus price you actually paid equals consumer surplus.)

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FT5: When the price of Apple computers goes down, what probably happens
to the demand for Windows-based computers?

A: The demand for Windows-based computers probably falls—remember

that this means the entire demand curve shifts down/to the left. The demand
for Windows-based computers falls when the price of Macs goes down
because Windows-based computers and Macs are substitutes. Thus, when the
price of Macs goes down, people switch to buying more Macs and fewer
Windows-based computers at any particular price.

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FT10: When is a pharmaceutical business more likely to hire highly educated,
cutting-edge workers and use new, experimental research methods: When the
business expects the price of its new drug to be low or when it expects the
price to be high?

A: A pharmaceutical business will invest more in research, including hiring the

very best researchers, when they expect new drug prices to be higher.

FT11: Imagine that a technological innovation reduces the costs of producing

high-quality steel. What happens to the supply curve for steel?

A: The supply of steel will increase. Lower costs shift the supply curve down
and to the right.
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FT12: When oil companies expect the price of oil to be higher next year, what
happens to the supply of oil today?

A: When they expect the price to rise in the future, they cut supply today. “Oil
now” and “oil next year” are substitutes in production so when the price of oil
is expected to be high next year firms will devote fewer resources to producing
oil this year and more to producing oil next year.

FT13: Do taxes usually increase the supply of a good or reduce the supply?

A: To a firm, taxes are equivalent to higher costs which shifts the supply curve
up and to the left. In other words, higher taxes cause supply to fall.

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PS9: If the price of glass dramatically increases, what are we likely to see a
lot less of: Glass windows or glass bottles? Why?

A: We’ll probably see a big decline in glass bottles, but only a small decline
in glass windows. Plastic is a good substitute for glass in the manufacturing
of bottles, but not as good a substitute for windows. Thus, we would
probably see a greater percentage decline in glass bottles than in windows.

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PS11. If income increases and the demand for good X shifts as shown below, then
is good X a normal or inferior good? Give an example of a good like good X.

A: Inferior. The shift is a fall in demand, and

when a rise in income causes a fall in demand,
that’s the definition of an “inferior good.” Ramen
noodles, secondhand clothes, and Hamburger
Helper are all examples of inferior goods for most
people in rich countries like the United States.
(Note: All of these goods might be normal goods
for people living in the world’s poorest
countries.)
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PS14: Suppose that the supply curve for solar panels is as shown in the diagram:
The government decides that it would like to increase the quantity of solar panels
in use, so it offers a $20 subsidy per panel to producers. Draw the new supply
curve.

A: The $20 subsidy

shifts the supply
curve down at each
point along the
curve by exactly
$20 so the old and
new supply curves
look like this:

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C1: Michael is an economist. He loves being an economist so much that he
would do it for a living even if he only earned $30,000 per year. Instead, he
earns $80,000 per year. (Note: This is the average salary of new economists
with a Ph.D. degree.) How much producer surplus does Michael enjoy?

A: He enjoys $50,000 of producer surplus.

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C2: The economist Bryan Caplan recently found a pair of $10 arch supports that
saved him from the pain of major foot surgery. As he stated on his blog
(econlog.econlib.org), he would have been willing to pay $100,000 to fix his foot
problem, but instead he only paid a few dollars.

a. How much consumer surplus did Bryan enjoy from this purchase?
b. If the sales tax was 5 percent on this product, how much revenue did the
government raise when Bryan bought his arch supports?
c. If the government could have taxed Bryan based on his willingness to pay rather
than on how much he actually paid, how much sales tax would Bryan have had to
pay?

A: a. $99,990; b. 50 cents; c. $5,000

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C4: What should happen to the “demand for speed” (measured by the average
speed on highways) once airbags are included on cars?

A: Airbags decrease the costs associated with driving fast by decreasing injuries
caused by high-speed crashes, thus the demand for speed increases, raising the
average speed. As a result, safety devices such as airbags and mandatory
seatbelts tend to increase the safety of car drivers and passengers (although not
as much as if there were no increase in speed), but decrease the safety of
pedestrians.

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C5: The industrial areas in northeast Washington, DC, were relatively
dangerous in the 1980s. Over the last two decades, the area has become a safer
place to work (although there are still seven times more violent crimes per
person in these areas compared with another DC neighborhood, Georgetown).
When an area becomes a safer place to work, what probably happens to the
“supply of labor” in that area?

A: A decrease in crime reduces the costs of supplying labor in crime prone

neighborhoods thus the supply curve for labor shifts down and to the right, i.e.
there is an increase in labor supply.

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