1. American and Japanese workers can each produce 4 cars a year. An American worker can produce 10 tons of grain a year, whereas a Japanese worker can produce 5 tons of grain a year. To keep things simple, assume that each country has 100 million workers.
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- Graph the production possibilities frontiers for the American and Japanese economies.
- For the United States, what is the opportunity cost of a car? Of grain? For Japan, what is the opportunity cost of a car? Of grain?
- Which country has an absolute advantage in producing cars? In producing grain?
- Which country has a comparative advantage in producing cars? In producing grain?
- Without trade, half of each country’s workers produce cars and half produce grain. What quantities of cars and grain does each country produce?
- Starting from a position without trade, give an example in which trade makes each country better off.
- Are the following statements true or false? Explain in each case.
- “Two countries can achieve gains from trade even if one of the countries has an absolute advantage in the production of all goods.”
- “Certain talented people have a comparative advantage in everything they do.”
- “If a certain trade is good for one person, it can’t be good for the other one.”
- “If a certain trade is good for one person, it is always good for the other one.”
- “If trade is good for a country, it must be good for everyone in the country.”
- For each of the following events, explain the short-run effects on output and the price level, assuming policymakers take no action and draw graphs to illustrate your answers.
- The stock market declines sharply, reducing consumers’ wealth.
- The federal government increases spending on national defense.
- A technological improvement raises productivity.
- A recession overseas causes foreigners to buy fewer U.S. goods.
- Explain why the following statements are false.
- “The aggregate-demand curve slopes downward because it is the horizontal sum of the demand curves for individual goods.”
- “The long-run aggregate-supply curve is vertical because economic forces do not affect long-run aggregate supply.”
- “If firms adjusted their prices every day, then the short-run aggregate-supply curve would be horizontal.”
- “Whenever the economy enters a recession, its long-run aggregate-supply curve shifts to the left.”
- The economy is in a recession with high unemployment and low output.
- Draw a graph of aggregate demand and aggregate supply to illustrate the current situation. Be sure to include the aggregate-demand curve, the short- run aggregate-supply curve, and the long-run aggregate-supply curve.
- Identify an open-market operation that would restore the economy to its natural rate.
- Draw a graph of the money market to illustrate the effect of this open-market operation. Show the resulting change in the interest rate.
- Draw a graph similar to the one in part a to show the effect of the open-market operation on output and the price level. Explain in words why the policy has the effect that you have shown in the graph.