Suggestions for problem set 1


There are two main concepts exploited on this problem set: production possibilities curves and sets and the model of supply and demand. Problems 1, 2, and 3 deal with production possibilities curves and sets. Problems 4 and 5 deal with the model of supply and demand.


Chapter 3 of the text, pages 29-37 (in the tenth edition of the text) discusses production possibilities curves. Review these pages if you are having difficulty with problems 1, 2, or 3. A production possibilities curves represents different combinations of two goods that could be produced from a given amount of (productive) resource(s). Productive resources are items such as labor that are used to produce goods. For example, in problem 1 the two goods which can be produced are war goods and civilian goods, both of which are produced using labor, the lone productive resource. The production possibilities curve and set referred to in this problem involve the alternative combinations of war goods and civilian goods that the country can produce given the total amount of labor it has available to produce these goods. In a graph of the production possibilities curve for the country, the quantities produced of these goods are plotted on the two axes. The problem describes how much labor is required to produce each unit of civilian and war goods, which is the key to constructing the country’s production possibilities curve for civilian and war goods. This problem and problems 2 and 3 address issues concerning opportunity cost. Review the definition of opportunity cost on p. 30 of the text and the discussion of the link between the shape of the production possibilities curve and how the opportunity cost of each good changes as more (or less) of the good is produced. This latter notion is emphasized in problem 3. A key to understanding opportunity cost and how to apply it is understanding that the opportunity cost of something is what has to be sacrificed to achieve it.


Problems 4 and 5 involve the model of supply and demand. The key ideas in the model of supply and demand are: 1) What supply and demand curves represent; 2) How a supply and demand curve define a unique "equilibrium" price and output; 3) What events shift each of the two curves; 4) How events are expected to influence price and output. Regarding what the curves represent, beginning with the demand curve, for any good it presents the amount of the good buyers would purchase at each possible price of the good, holding constant the amount of income they have available to purchase all goods and the prices of all other goods. It is important to realize it is a hypothetical schedule—for each possible price of the good, it indicates how much buyers would purchase. It does not indicate anything about what the price will be, just how much would be purchased at each possible price. Similarly, a supply curve is a hypothetical schedule indicating how much suppliers would be willing to sell of a good at each possible price for the good. It is the combination of the supply and demand curve that defines the price of the good that will prevail and in the process the quantity that will be purchased and sold. Review pages ii and iii in the problem sets regarding how supply and demand curves define an equilibrium price and output and why this price and output are expected to prevail.


Regarding shifts in demand and supply curves, a key is to understand the meaning of a shift. Take the demand curve, for example. It indicates the amount buyers would purchase at each possible price. In order for the demand curve to shift, it must be the case that at some price, demanders would now want to buy a different amount of the good. If the demand curve shifts at every price, then at every price demanders would want to buy a different amount than previously. Thus, for an event to cause the demand curve to shift, it must affect the amount demanders would want to purchase at some price(s). Think about goods you purchase. Holding the price constant, what could cause you to alter the amount you would want to purchase of the good? It is such events that contribute to shifts in the demand curve. Think about whether the events would cause you to increase or decrease the quantity you would want to purchase and thus which way the demand curve would shift. Similarly, events that cause the supply curve to shift are events which would change the amount suppliers would want to sell at a given, constant price. Holding price constant, what events would cause suppliers to change the amount they would want to sell, and in what direction would the supply curve shift? Last, review pp. iii and iv in the problem sets about how shifts in demand and supply curves contribute to changes in price and quantity.


Once you understand the four key issues above, you are ready to attack problems like problem 4 that requires you to put all the key issues together. In the first part of this problem, you have to think whose behavior the advertising campaign is targeted at and whether the targets determine the supply or demand curve. The relevant event here is the advertising campaign. If you can figure out how the event causes the supply and/or demand curves to shift, and you understand how shifts in demand and supply curves lead to specific changes in price and output, then you should be able to answer all the parts of the question. The key to answering a problem like this is to ask how the event would affect the amount demanders or suppliers would want to buy or sell at a given price, how this translates into a shift of the demand or supply curve, and how such a shift affects price and/or output.


Quiz 1 is about production possibilities curves and opportunity cost. A good way to proceed on a problem like this is to graph the production possibilities curve since you are given all the information you need to graph the curve. Start with the intercepts of the graph. How would you compute them? What do your calculations tell you about the answers to questions 1 and 2? Then graph some intermediate points until you get a sense of the whole curve. What does the shape of the curve tell you about the answers to questions 4 and 5? What does its slope tell you about the answer to question 3? Keep in mind that the minitest you will eventually take (see the syllabus for the meeting of the discussion section when minitest 1 will be administered) is often (but not always) similar to the quiz in that similar issues are covered. Make sure you understand the issues covered in the quiz.