1.  What determines the slope of the consumption choice budget constraint? The labor-leisure budget constraint? The intertemporal budget constraint?

Below are 3 quotes from our book

2.  Explain why individuals make choices that are directly on the budget constraint, rather than inside the budget constraint or outside it.

Paraphrased from our book.

The logic of the budget constraint dictates that the choice will be a point on the actual budget constraint itself—not a choice that is above the budget set or below it. We might desire a point  outside the budget constraint, but we  can’t afford it. Conversely, we won’t choose a point which is inside the boundary of the budget constraint, because we could instead select a choice on the budget set itself that would have at least as much of one good and more of the other—or a choice that would offer even more of both goods. In this simple model, we don’t have any other goods on which to spend money, and so if we doesn’t spend the money, it is wasted.

3.  What does it mean to “maximize utility”?

In economics, utility refers to the level of satisfaction or pleasure that people receive from their choices. Thus, when people make the choices that provide the highest level of satisfaction, economists say that they are "maximizing utility."

4. What are the three components of the interest rate?

1. Risk of not being repaid. The future is uncertain. Part of the interest rate is a risk premium, that is, a payment to make up for the risk of not being repaid in full.

2. Inflation. In most years, there is a rise in the price level called inflation. A lender demands an interest rate in part to compensate for any expected inflation, so that the money that is repaid in the future will have at least as much buying power as the money that was originally loaned.

3. Time value of money. If you have the money now, you can spend it on something now if you wish to do so and receive benefits from that spending. Being forced to wait is an intangible cost, but still a cost. This cost of having to wait is referred to as the time value of money.

5.  What is opportunity cost?

opportunity cost: Whatever must be given up to obtain something that is desired.  This includes both and explicit cost and an implicit cost.

6.  Imagine a society that produces military goods and consumer goods, which we’ll call “guns” and “butter”.

a.       Draw a production possibilities frontier for guns and butter. Explain why it most likely has a bowed out shape?

b.       Show a point that is impossible for the economy to achieve. Show a point that is feasible and inefficient.

c.       Imagine that the society has two political parties, called the Hawks (who want a strong military) and the Doves (who want a smaller military). Show a point on your production possibilities frontier that the Hawks might choose and a point the Doves might choose.

d.       Imagine that an aggressive neighboring country reduces the size of its military. As a result, both the Hawks and the Doves reduce their desired production of guns by the same amount. Which party would get the bigger “peace dividend,” measured by the increase in butter production? Explain.

6.   a.   The Figure below shows a production possibilities frontier between guns and butter. It is bowed out because the opportunity cost of butter depends on how much butter and how many guns the economy is producing. When the economy is producing a lot of butter, workers and machines best suited to making guns are being used to make butter, so each unit of guns given up yields a small increase in the production of butter. Thus, the frontier is steep and the opportunity cost of producing butter is high. When the economy is producing a lot of guns, workers and machines best suited to making butter are being used to make guns, so each unit of guns given up yields a large increase in the production of butter. Thus, the frontier is very flat and the opportunity cost of producing butter is low.

Figure

      b.   Point A is impossible for the economy to achieve; it is outside the production possibilities frontier. Point B is feasible but inefficient because it is inside the production possibilities frontier.

      c.    The Hawks might choose a point like H, with many guns and not much butter. The Doves might choose a point like D, with a lot of butter and few guns.

      d.   If both Hawks and Doves reduced their desired quantity of guns by the same amount, the Hawks would get a bigger peace dividend because the production possibilities frontier is much flatter at point H than at point D. As a result, the reduction of a given number of guns, starting at point H, leads to a much larger increase in the quantity of butter produced than when starting at point D.

7.  The primary principle of economics is that people face tradeoffs. Use a production possibilities frontier to illustrate society’s tradeoff between a clean environment and the quantity of industrial output. What do you suppose determines the shape and position of the frontier? Show what happens to the frontier if engineers develop an automobile engine with almost no emissions.

7.   See Figure 7. The shape and position of the frontier depend on how costly it is to maintain a clean environment¾the productivity of the environmental industry. Gains in environmental productivity, such as the development of new way to produce electricity that emits fewer pollutants, lead to shifts of the production-possibilities frontier, like the shift from PPF₁ to PPF₂ shown in the figure.

 

         Michael and Angelo live in a small town in Italy.  They work as artists.  Michael is the more productive artist.  He can produce 10 small sculptures each day but only 5 paintings.  Angelo can produce 6 sculptures each day but only 2 paintings.

a.       What is the opportunity cost of a painting for each artist?

b.      Based on you answer in part a, who has the comparative advantage in producing paintings.

c.       If the two men decide to specialize, who should produce the sculptures and who should produce the paintings.

a.  The opportunity cost of paintings for Michael is 10 sculptures for 5 paintings or reduced it is 2 sculptures for 1 painting

      The opportunity cost of paintings for Angelo is 6 sculptures for 2 paintings or reduced it is 3 sculptures for 1 painting.

b.  Michael has a lower OC so he has the CA at paintings.

c.  Michael should specialize in paintings and Angelo should specialize in schultpures.