1. A worker in Rhode Island can produce 1 pound of corn in 15 minutes and 1 poun

Question

1. A worker in Rhode Island can produce 1 pound of corn in 15 minutes and 1 pound of shucked oysters in 10 minutes. A worker in South Carolina can produce 1 pound of corn in 20 minutes and 1 pound of shucked oysters in 60 minutes. Which state’s worker has an absolute advantage in corn and which state’s worker has an absolute advantage in shucked oysters? Which state has a comparative advantage in corn and which state has a comparative advantage in shucked oysters? At what price will trade occur between the two states for corn and at what price for oysters? Explain your answers.

2. We discussed the possibility that a startup firm in San Francisco plans to 3-D print Rhinoceros horns that are indistinguishable from real horns. Assume they are able to produce these horns cheaply. If successful, what will happen to the market price and quantity of horns in the market? (real and 3-D printed are sold in one market for “horns”) Explain your answer thoroughly.

3. Suppose the price elasticity of demand for heating oil is 0.2 in the short run and 0.7 in the long run. If the price of heating oil rises from $1.80 to $2.20 per gallon, what happens to the quantity of heating oil demanded in the short run? In the long run? (Use the midpoint method in your calculations) Why might this elasticity depend on the time horizon?

4. If there is a sudden improvement in the production of heroin and cold medication (the production of both products are improved by the same amount) how will the changes in the market differ? Provide a detailed economic analysis.   

Explanation / Answer

(1)

Rhode Island makes Oyester at a lower cost (hours) than it can make Corn (10 minutes < 15 minutes).

So, it has absolute advantage in oyester which it can produce at lower unit cost (hours).

South carolina makes corn at a lower cost (hours) than it can make oyester (20 minutes < 60 minutes).

So, it has absolute advantage in corn which it can produce at lower unit cost (hours).

In 1 minute, Rhode Island makes (1 / 15) = 0.07 Corn and (1 / 10) = 0.10 Oyester.

Its opportunity cost of corn = 0.10 / 0.07 = 1.43 oyesters

In 1 minute, South carolina makes (1 / 20) = 0.05 Corn and (1 / 60) = 0.02 Oyester.

Its opportunity cost of corn = 0.02 / 0.05 = 0.4 oyesters.

Since South carolina can make corn at a lower opportunity cost than Rhode Island (0.4 < 1.43 oyesters), it has comparative advantage in corn.

Conversely, Rhode Island has comparative advantage in making oyesters.

Trading price of corn will lie between its opportunity costs:

0.4 < P(Corn) < 1.43

Trading price of oyster will lie between its opportunity costs:

(1/1.43) < P(Oyster) < (1/0.4)

0.7 < P(Oyster) < 2.5

(2)

Assuming aritificial horns are perfect substitute for real horns, supply of horns will increase and therefore, price of horns will decrease overall.

(3)

(a) Short Run

Change in price = [2.2 - 1.8] / [(2.2 + 1.8) / 2] = 0.4 / 2 = 0.2, or 20% increase.

Since price elasticity = 0.2 (assuming a Negative 0.2), a 20% increase in price will decrease quantity demanded by (20% x 0.2) = 4%.

(b) Long run

Change in price = [2.2 - 1.8] / [(2.2 + 1.8) / 2] = 0.4 / 2 = 0.2, or 20% increase.

Since price elasticity = 0.7 (assuming a Negative 0.7), a 20% increase in price will decrease quantity demanded by (20% x 0.7) = 14%.

(c) Elasticity depends on time horizon because, in the long run many economic variables are flexible and consumers can change their consumption pattern (for example, by switching to a newly introduced substitute) in response to price change.

NOTE: Out of 4 questions, the first 3 are answered.

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