AP Macroeconomics Unit 1 Review Session

Production Possibilities Curve, Absolute and Comparative Advantage, Opportunity Cost, and Marginal Analysis

1. Draw a PPC with linear opportunity cost.

2. Draw a PPC that illustrates the law of increasing opportunity cost.

Use the figure below to answer Questions 3-6.

3. What is the opportunity cost of 1 unit of textiles in the US? In Portugal?

4. What is the opportunity cost of 1 unit of wine in the US? In Portugal?

5. Assume the two countries have identical resources. a. In which product does the US have an absolute advantage? In which product does Portugal have an absolute

advantage?b. In which product does the US have a comparative advantage? In which product does Portugal have a comparative

advantage?

Fill in the table. Assume that with trade, each country specializes and exports ½ of its production.Without Trade With Trade (Production) With Trade (Consumption)

Wine Textiles Wine Textiles Wine TextilesPortugalUnited StatesTotal

6. What happens to total world output when countries specialize and trade? What is this called?

7. For each of the following scenarios, describe the opportunity cost of each decision.a. Sarah considers two options for Saturday night: she can attend a concert that costs $10 per ticket or she can see a

free movie. She attends the concert. b. A new firm debates paying $20,000 for the prime location versus $10,000 for another location. The firm estimates

that it will eventually serve the same number of customers in either location, but that it will take six months before the suboptimal location provides the same outcome as the prime location. The firm purchases the $10,000 property.

c. Jamie can either be an unpaid intern at a company or he can earn $2,000 working as a camp counselor. He takes the internship.

8. The following table presents the possible combinations of study time available to Roberto this week as he prepares for his two midterms: economics and chemistry. Assume Roberto has 20 hours to study and that he will use all 20 hours studying economics and chemistry. Roberto currently plans to study 10 hours for economics and 10 hours for chemistry.

Hours of study timespent on economics

Hours of study timespent on chemistry

Grade in economics Grade in chemistry

0 20 60 905 15 70 85

10 10 80 7515 5 86 7320 0 90 70

a. If he alters his plan and studies 15 hours for economics, what is his opportunity cost?b. If he alters his plan and studies 15 hours for chemistry, what is his opportunity cost?c. If he alters his plan and studies 20 hours for economics, what is his opportunity cost?

9. The country of Utopia produces two goods from its available resources and technology. The only resource that Utopia has is labor. It takes 3 hours to produce 2 widgets and 4 hours of labor to produce 1 gadget. Assume a linear PPC.

a. Sketch the PPC for the country of Utopia. (Use 24 hours as your labor constraint and sketch your PPC based on this amount of time and labor. Measure widgets on the y axis.)

b. What is the slope of your PPC?c. What is the opportunity cost of producing an additional widget in Utopia? d. What is the opportunity cost of producing an additional gadget in Utopia?

10. The country of Jonesville produces two goods from its available resources and technology. The only resource that Jonesville has is labor. It takes 2 hours of labor to produce a gadget and 5 hours of labor to produce a widget. For this question, assume that the PPC for Jonesville is linear.

a. Sketch the PPC for Jonesville assuming that it has 120 hours of labor available.

b. What is the opportunity cost of producing an additional gadget?c. What is the opportunity cost of producing an additional widget?d. Suppose that Jonesville has 240 hours of labor available instead of 120 hours of labor. Does this affect the

opportunity costs? Explain.

11. The following table provides six possible production combinations that Smithtown can produce from its available resources and technology during this year. Assume that Smithtown produces only bicycles and tents from its available resources.

Combination Bicycles TentsA 100 0B 90 10C 70 25D 40 36E 10 42F 0 45

a. Sketch Smithtown’s PPC. (Measure bicycles on the x axis for this example.)b. Suppose Smithtown is currently producing as combination C. If Smithtown chooses to produce at combination B,

what is the opportunity cost of moving from combination C to B?c. Suppose Smithtown is currently producing at combination C. If Smithtown choses to produce at combination D,

what is the opportunity cost of moving from combination C to D?d. Is Smithtown’s PPC linear? Explain.

12. There are two islands in the middle of the ocean, and these two islands produce fish and baskets. Big Island can produce either 100 fish per day and 0 baskets per day or 0 fish per day and 200 baskets per day. Big Island can also produce any combination of goods that lies on its linear PPC. Small Island can produce either 80 fish per day and 0 baskets per day or 0 fish per day and 80 baskets per day. Like Big Island, Small Island has a linear PPC. (Measure fish on the y axis.)

a. Sketch the PPCs for Big Island and Small Island.b. What is the slope of Big Island’s PPC? Of Small Island’s PPC?c. What is the opportunity cost of producing an additional basket on Big Island? On Small Island? Which island can

produce baskets at a lower opportunity cost?d. What is the opportunity cost of producing an additional fish on Big Island? On Small Island? Which island can

produce fish at a lower opportunity cost?e. What good should Big Island specialize in producing? What good should Small Island specialize in producing?

Positive and Normative Economics

13. Decide whether each of the statements is a normative statement or a positive statement.a. The gasoline tax is projected to yield $10 million in tax revenue next year.b. If the gasoline tax were raised by 10 cents per gallon, tax revenue would increase by 4%.c. The state should raise the gasoline tax for the coming year. An increase will reduce congestion and smog, which is

more important than the cost to commuters.d. Mandatory school enhances the work skills of students.e. The age of mandatory school attendance should be extended.f. An extension of mandatory school attendance will increase government education costs by $2 million for the state.

14. Define positive economics and normative economics. Why does normative economics cause greater disagreement among economists?

Supply and Demand

15. Graph supply and demand curves, indicating equilibrium price and quantity on the axes.

16. Draw a correctly labeled graph showing the effect on equilibrium price and quantity in the market for oranges when, ceteris paribus, each of the following changes occurs.

a. There is a freeze in Florida that kills many of the orange groves.

b. The wages of orange workers decrease.

c. Research finds oranges have additional health benefits.

d. The price of tangerines decreases.

17. The following chart shows the quantity demanded in the competitive market for bicycles.

Price per bicycle Quantity of bicycles demanded per week

$100 080 10060 20040 50020 8000 1,000

a. Suppose the price is initially $40. If price rises by $20, what happens to the quantity demanded?b. Suppose the price is initially $40. If price falls by $40, what happens to quantity demanded?

18. For each of the following scenarios (in the table below), fill in the missing information. Does that scenario cause a shift of or movement along the demand curve? If a shift occurs, does the demand curve shift to the right or left?

Scenario Specified market Movement (M)or shift (S)

Demand shift right (->) or left (<-)

People’s income increases Market for exotic vacationsPeople’s incomes decreases. Market for goods sold in secondhand

shopsPrice of bicycles increases. Market for bicyclesPrice of tennis balls increases. Market for tennis racquetsPrice of movie tickets decreases. Popcorn at movie theaterPopularity of music playing device increases.

Market for music-playing devices

Popularity of name-brand clothing items decreases.

Market for band-name designer clothing

Winter clothing is expected to go on sale next month.

Market for winter clothing

Number of urban residents increases. Market for apartments in urban areas

19. The following graph represents the supply curve for the production of widgets in Town Center.

a. At a price of $20, how many widgets are producers willing to supply?b. At a price of $40, how many widgets are producers willing to supply?c. Suppose there are ten widget producers in Town Center and the price of widgets is $50. If each producer produces

the same number of widgets, how many widgets will each produce?d. Suppose price is initially $30 but then falls to $20. What is the change in quantity supplied?e. Suppose price is initially $30 but then rises to $50. What is the change in quantity supplied?f. What price must suppliers receive in order to be willing to supply 80 widgets?g. What price must suppliers receive in order to be willing to supply 40 widgets?h. How does the slope of a supply curve reflect the relationship between price and quantity supplied?

20. For each of the following scenarios (in the table below), fill in the missing information. Does that scenario cause a shift of or movement along the supply curve? If a shift occurs, does the supply curve shift to the right or left?

Scenario Specified market Movement (M)or shift (S)

Supply shift right (->) or left (<-)

Labor costs for air travel and cruise ships increase.

Market for exotic vacations

Prices of office equipment and phone service rise by 40%

Market for call center services

Price of bicycles increases. Market for bicyclesPrice of leather boots increases. Market for beef productsPrice of leather boots increases. Market for leather beltsNew technology for music players revealed.

Market for music-playing devices

Price of brand-name designer clothing increases.

Market for brand-name designer clothing

Number of coffee shop owners in the metro area increases.

Market for coffee in the metro area

21. The demand and supply schedules for Healthy Snacks, Inc., is provided in the table below.

Price Quantity demanded Quantity supplied$0 1,000 010 800 12520 600 27530 400 40040 200 55050 0 675

a. Sketch the demand and supply curves for Healthy Snacks, Inc. Don’t worry about being precise. Focus on drawing the relationships.

b. Indicate equilibrium price and quantity.c. Fill in the following table based on the data given. (Hint: If there is excess in supply, there is no excess demand –

and vice versa.)

Price Excess demand Excess supply Shortage or Surplus?$01020304050

22. For each of the following scenarios, draw a correctly labeled graph showing the effect on equilibrium price and quantity when, ceteris paribus, each of the following changes occurs. Indicate initial market demand (D1), supply (S1), equilibrium price (P1), and equilibrium quantity (Q1) – as well as any changes to the market demand (D2), and/or supply (S2) curves, and indicate the new equilibrium price (P2) and quantity ( Q2).

a. The price of gasoline increases by 40 percent. What happens in the market for bicycles?b. The price of gasoline increases by 40 percent. What happens in the market for fuel-inefficient SUVs?c. New technology for music-playing is developed? What happens in the market for these devices?d. The price of labor decreases. What happens in the market for fast-food restaurants?e. Income increases and good X is a normal good. What happens in the market for good X?f. Income increases and good X is an inferior good. What happens in the market for good X?

Price Floors and Price Ceilings

23. Consider the market for housing in Metropolitan City, where all housing units are exactly the same. Currently, the equilibrium price of housing is $2,000 a month and local residents consume 1,500 units of housing. The local residents

argue that housing is too expensive and an effective price ceiling is implemented. When the price ceiling is implemented by the local government council, only 1,200 units of housing are supplied. Is this an efficient level of housing for Metropolitan City? Explain and use a graph to show equilibrium quantity and price, as well as the price ceiling and the quantity supplied and quantity demanded after the price ceiling is implemented.

24. Use the graph below to answer the following questions.

a. What is the equilibrium price? Equilibrium quantity?b. Suppose a price floor of P3 is implemented by the government in this market. What will happen to the price and

quantity once this price floor is implemented?c. Suppose a price floor of P2 is implemented by the government in this market. What will happen to the price and

quantity once this price floor is implemented?d. You are told that an effective price floor has been implemented in this market and the resultant surplus is greater

than Q4-Q1. What do you know about the level of this price floor?e. Where must be true for a price floor to be effective?f. Suppose a price ceiling of P2 is implemented by the government in this market. What will happen to the price and

quantity once this price ceiling is implemented?g. Suppose a price ceiling of P3 is implemented by the government in this market. What will happen to the price and

quantity once this price ceiling is implemented?h. You are told that an effective price ceiling has been implemented in this market and the resultant shortage is less

than Q5-Q2. What do you know about the level of this price ceiling?i. Where must be true for a price ceiling to be effective?

25. The market for taxi rides in Metropolitan City is described in the following table. Assume all taxi rides are the same.

Price of taxi rides Quantity of taxi rides demanded per week

Quantity of taxi rides supplied per week

$1 200 402 180 603 160 804 140 1005 120 1206 100 1407 80 1608 60 1809 40 200

10 20 220a. What is the equilibrium price and quantity of taxi rides in Metropolitan City per week? b. Suppose the government institutes a medallion system that limits the number of taxi rides available in

Metropolitan City to 80 per week. At what price will consumers want to purchase 80 taxi rides per week? At what price will suppliers be willing to supply 80 taxi rides per week?

c. What price will a taxi medallion rent for in this market? Explain.d. Graph the taxi ride market in Metropolitan City. On this graph, indicate the equilibrium price and quantity, the

quota limit, the demand price, the supply price, and the medallion’s rental price.

e. What is total value of the taxi medallions per week in Metropolitan City?