AIU Exam – Markets & Decision Making

School: Business & Economics

Major: Economics

Course title: Markets & Decision Making

Credits for course: 3 credits
Description of course:
 The effects of taxes on supply and
demand
 What determines who really bears
the burden of a tax
 The costs and benefits of taxes, and
why taxes impose a cost that is
greater than the tax revenue they
raise
 The difference between progressive
and regressive taxes and the trade-
off between tax equity and tax
efficiency
 The structure of the U.S. tax System
 Why good decision making begins
with accurately defining costs and
benefits
 The importance of implicit and
explicit costs in decision making
 How accounting profit and economic
profit differ, and why economic profit
is the correct basis for decisions
 Why there are three different types
of economic decisions: “either–or,”
“how much,” and those involving
sunk costs
 The principles of decision making
that correspond to each type of
economic decision
 Why people sometimes behave in
irrational yet predictable ways
 How to make decisions involving
time

Book & chapter: Economics by Paul Krugman, Chapters 3 and 4

Link to book:

http://aiustudev.aiu.edu/submissions/profiles/resources/onlineBook/a7C6g6_krugman
%20economics.pdf
Bibliography of book:

Krugman, Paul. Robin Wells. "Economics." Worth Publishers, 4th Edition (2015).
.

Format of the assignment: Assignment must have an AIU cover page, introduction to
the topics of the chapter, answers to the questions below, conclusion about the exam
and the bibliography of book at end of assignment.

Instructions for Adding Course & Submitting Exam: Go to the top of your student
platform. On the left you will see a link to add a course called “Add Courses into Curriculum”.
Click there. Then you will see a button to add a new course. It will then ask you to give the
specific name of the course, which is given above on this exam.
Then you submit the assignment through another link at the top of the platform called “Submit
an assignment”. You choose the course name from the drop-down list. Then you choose to
send the assignment “offline”. Then you upload the file(s) for the course.

Please include questions with your answers, so that we can see the question being
answered.

Questions…

Chapter 3

1. Both Canada and the United States produce lumber and footballs with constant opportunity
costs. The United States can produce either 10 tons of lumber and no footballs, or 1,000
footballs and no lumber, or any combination in between. Canada can produce either 8 tons of
lumber and no footballs, or 400 footballs and no lumber, or any combination in between.
a. Draw the U.S. and Canadian production possibility frontiers in two separate diagrams,
with footballs on the horizontal axis and lumber on the vertical axis.
b. In autarky, if the United States wants to consume 500 footballs, how much lumber can
it consume at most? Label this point A in your diagram. Similarly, if Canada wants to
consume 1 ton of lumber, how many footballs can it consume in autarky? Label this
point C in your diagram.
c. Which country has the absolute advantage in lumber production?
d. Which country has the comparative advantage in lumber production? Suppose each
country specializes in the good in which it has the comparative advantage, and there
is trade.
e. How many footballs does the United States produce? How much lumber does Canada
produce?
f. Is it possible for the United States to consume 500 footballs and 7 tons of lumber?
Label this point B in your diagram. Is it possible for Canada at the same time to
consume 500 footballs and 1 ton of lumber? Label this point D in your diagram.

2. For each of the following trade relationships, explain the likely source of the comparative
advantage of each of the exporting countries.
a. The United States exports software to Venezuela, and Venezuela exports oil to the
United States.
b. The United States exports airplanes to China, and China exports clothing to the
United States.
c. The United States exports wheat to Colombia, and Colombia exports coffee to the
United States.

3. Since 2000, the value of U.S. imports of men’s and boy’s apparel from China has more than
tripled. What prediction does the Heckscher-Ohlin model make about the wages received by
labor in China?

4. Shoes are labor-intensive and satellites are capital intensive to produce. The United States
has abundant capital. China has abundant labor. According to the Heckscher–Ohlin model,
 which good will China export? Which good will the United States export? In the United States,
what will happen to the price of labor (the wage) and to the price of capital?
5. The accompanying table indicates the U.S. domestic demand schedule and domestic supply
schedule for commercial jet airplanes. Suppose that the world price of a commercial jet
airplane is $100 million.

a. In autarky, how many commercial jet airplanes does the United States produce, and
at what price are they bought and sold?
b. With trade, what will the price for commercial jet airplanes be? Will the United States
import or export airplanes? How many?

6. The accompanying table shows the U.S. domestic demand schedule and domestic supply
schedule for oranges. Suppose that the world price of oranges is $0.30 per orange.

a. Draw the U.S. domestic supply curve and domestic demand curve.
b. With free trade, how many oranges will the United States import or export? Suppose
that the U.S. government imposes a tariff on oranges of $0.20 per orange.
c. How many oranges will the United States import or export after introduction of the
tariff?
d. In your diagram, shade the gain or loss to the economy as a whole from the
introduction of this tariff.
7. The accompanying diagram illustrates the U.S. domestic demand curve and domestic supply
curve for beef.

The world price of beef is PW. The United States currently imposes an import tariff on beef, so
the price of beef is PT . Congress decides to eliminate the tariff. In terms of the areas marked in
the diagram, answer the following questions.
a. With the elimination of the tariff what is the gain/loss in consumer surplus?
b. With the elimination of the tariff what is the gain/loss in producer surplus?
c. With the elimination of the tariff what is the gain/loss to the government?
d. With the elimination of the tariff what is the gain/loss to the economy as a whole?

8. As the United States has opened up to trade, it has lost many of its low-skill manufacturing
jobs, but it has gained jobs in high-skill industries, such as the software industry. Explain
whether the United States as a whole has been made better off by trade.

9. In World Trade Organization (WTO) negotiations, if a country agrees to reduce trade barriers
(tariffs or quotas), it usually refers to this as a concession to other countries. Do you think that
this terminology is appropriate?

10. Producers in import-competing industries often make the following argument: “Other
countries have an advantage in production of certain goods purely because workers abroad
are paid lower wages. In fact, American workers are much more productive than foreign
workers. So import-competing industries need to be protected.” Is this a valid argument?
Explain your answer.

Chapter 4

11. Jackie owns and operates a website design business. To keep up with new technology, she
spends $5,000 per year upgrading her computer equipment. She runs the business out of a
room in her home. If she didn’t use the room as her business office, she could rent it out for
$2,000 per year. Jackie knows that if she didn’t run her own business, she could return to her
previous job at a large software company that would pay her a salary of $60,000 per year.
Jackie has no other expenses.
a. How much total revenue does Jackie need to make in order to break even in the eyes
of her accountant? That is, how much total revenue would give Jackie an accounting
profit of just zero?
 b. How much total revenue does Jackie need to make in order for her to want to remain
self-employed? That is, how much total revenue would give Jackie an economic
profit of just zero?

12. You own and operate a bike store. Each year, you receive revenue of $200,000 from your
bike sales, and it costs you $100,000 to obtain the bikes. In addition, you pay $20,000 for
electricity, taxes, and other expenses per year. Instead of running the bike store, you could
become an accountant and receive a yearly salary of $40,000. A large clothing retail chain
wants to expand and offers to rent the store from you for $50,000 per year. How do you
explain to your friends that despite making a profit, it is too costly for you to continue running
your store?

13. You have bought a $10 ticket in advance for the college soccer game, a ticket that cannot
be resold. You know that going to the soccer game will give you a benefit equal to $20. After
you have bought the ticket, you hear that there will be a professional baseball post-season
game at the same time. Tickets to the baseball game cost $20, and you know that going to
the baseball game will give you a benefit equal to $35. You tell your friends the following: “If I
had known about the baseball game before buying the ticket to the soccer game, I would
have gone to the baseball game instead. But now that I already have the ticket to the soccer
game, it’s better for me to just go to the soccer game.” Are you making the correct decision?
Justify your answer by calculating the benefits and costs of your decision.

14. Amy, Bill, and Carla all mow lawns for money. Each of them operates a different lawn
mower. The accompanying table shows the total cost to Amy, Bill, and Carla of mowing
lawns.

a. Calculate Amy’s, Bill’s, and Carla’s marginal costs, and draw each of their marginal
cost curves.
b. Who has increasing marginal cost, who has decreasing marginal cost, and who has
constant marginal cost?

15. Georgia and Lauren are economics students who go to a karate class together. Both have
to choose how many classes to go to per week. Each class costs $20. The accompanying
table shows Georgia’s and Lauren’s estimates of the marginal benefit that each of them gets
from each class per week.
 a. Use marginal analysis to find Lauren’s optimal number of karate classes per week.
Explain your answer.
b. Use marginal analysis to find Georgia’s optimal number of karate classes per week.
Explain your answer.

16. The Centers for Disease Control and Prevention (CDC) recommended against vaccinating
the whole population against the smallpox virus because the vaccination has undesirable,
and sometimes fatal, side effects. Suppose the accompanying table gives the data that are
available about the effects of a smallpox vaccination program.

a. Calculate the marginal benefit (in terms of lives saved) and the marginal cost (in terms
of lives lost) of each 10% increment of smallpox vaccination. Calculate the net
increase in human lives for each 10% increment in population vaccinated.
b. Using marginal analysis, determine the optimal percentage of the population that
should be vaccinated.

17. Patty delivers pizza using her own car, and she is paid according to the number of pizzas
she delivers. The accompanying table shows Patty’s total benefit and total cost when she
works a specific number of hours.
 a. Use marginal analysis to determine Patty’s optimal number of hours worked.
b. Calculate the total profit to Patty from working 0 hours, 1 hour, 2 hours, and so on.
Now suppose Patty chooses to work for 1 hour. Compare her total profit from
working for 1 hour with her total profit from working the optimal number of hours.
How much would she lose by working for only 1 hour?

18. You have been hired as a consultant by a company to develop the company’s retirement
plan, taking into account different types of predictably irrational behavior commonly displayed
by employees. State at least two types of irrational behavior employees might display with
regard to the retirement plan and the steps you would take to forestall such behavior.