1. The production possibilities frontier (PPF) in the figure below shows the tradeoffs between
consumption goods (goods that are used for final consumption) and capital goods (goods that
are used in the production as inputs such as machinery and equipment). Suppose two countries:
Spendthrift and Frugal, face this identical PPF.
a) Suppose Spendthrift chooses to produce at point A while Frugal chooses to produce at point B.
Which country will experience higher growth in the future? Why? (1 point)
b) As you may have realized, growth will take place in both countries as a result of capital
accumulation. On two separate graphs, show the impact of growth on production possibilities
frontiers illustrating the difference between these two countries. Give a brief explanation Label
the graphs clearly. (1 point)
2. In July 2017, the retail price of gasoline was \$2.34 per gallon â€“ exactly the same as it was in
February 2005. Yet, total gasoline production and consumption rose from 9.6 million barrels per
week in 2005 to 12.7 million barrels per week in 2017. Using the graph below, draw the
appropriate shifts in the demand and supply curves to explain these two phenomena. Discuss
the changes in demand and supply. (2 points)
2
3. a) Suppose the current equilibrium price of cheese pizza is \$10, and 10 million pizzas are sold
per month. After the federal government imposes a \$0.50 per pizza tax, the equilibrium price of
pizzas rises to \$10.40, and the equilibrium quantity falls to 9 million. Illustrate this situation with
a demand and supply graph. Be sure your graph shows the equilibrium price before and after the
tax, and the equilibrium quantity before and after the tax. How is the tax burden divided
between buyers and sellers? Label the graph clearly. (3 points)
b) Imagine that the community you live in decides to enact a rent control of \$700 per month on
every one-bedroom apartment. Using the following table, determine the market price and
equilibrium quantity without rent control. How many one-bedroom apartments will be rented
after the rent-control law is passed? Draw a demand supply diagram and show the effect of rentcontrol. What will happen if rent ceiling is set at \$900? Label the graph clearly. (3 points)
Monthly rent Quantity demanded Quantity supplied
\$600 700 240
\$700 550 320
\$800 400 400
\$900 250 480
\$1,000 100

Sample Solution