ECO 200-810 Principles of Macroeconomics Homework #6 Answer Key
  1. Briefly describe the advantage and drawbacks to an open vs. closed economy with respect to policy, efficiency and competition.

    2. An open economy gives consumers the benefit of import competition, and the economy reaps the gains that come from specialization in goods with a comparative advantage.  However, fiscal and monetary policy become less powerful and more difficult in an open economy, where the economy conditions of other countries affect the domestic economy
     
  2. Consider the following model economy:


    3. C = 60 + .8Y G = 100

    I = 100 T = 0

    X-IM = 10
     

    1. What is the impact of a 10% increase in G on equilibrium expenditure if the MPM = 0?

      2. an increase of 10% in G is an increase of 10.
      the closed economy multiplier is 1/(1-.8) = 5.
      so the change in equilibrium expenditure is 10 x 5 = 50.
       
    2. What is the impact of a 10% increase in G on equilibrium expenditure if the MPM = .05?

      3. the open economy multiplier is 1/(1-.8+.05) = 4.
      so the change in equilibrium expenditure is 10 x 4 = 40.
  3. The tables below describe the domestic production possibilities of widgets and thingamabobs for Timmyland and Tangyland (yes, it is the end of the semester and I am not very creative):
    4. Timmyland
    Tangyland
    widgets
    things
    widgets
    things
    60
    0
    40
    0
    45
    5
    30
    4
    30
    10
    20
    8
    15
    15
    10
    12
    0
    20
    0
    16
    1. What is the opportunity cost of 1 thingamabob in Timmyland? In Tangyland?

      2. Timmyland must give up 15 widgets for every 5 things produced.  So the opportunity cost of 1 thing = 3 widgets.
      Tangyland must give up 10 widgets for every 4 things produced.  So the opportunity cost of 1 thing = 2.5 widgets.
       
    2. Draw the production possibilities frontiers for each country.


    3. Which country has an absolute advantage in the production of widgets? In the production of thingamabobs? Which country has a comparative advantage in the production of widgets?


      4. Timmyland has an absolute advantage in both widgets and thingamabobs because when specializing in either good, it can produce more (60 vs. 40 widgets, 20 vs. 16 things). Tangyland has a comparative advantage in things because they give up fewer widgets to make them.  Timmyland has a comparative advantage in widgets.
       

    4. Suppose the countries specialize completely in their comparative advantage good and trade with each other. Timmyland trade ministry offers to trade at the rate of 10 widgets for 20 thingamabobs. With Tangyland accept this trade? Why or why not?


      5. Actually, Tangyland cannot produce 20 thingamabobs, so the trade is not possible.
      However, if we look at the ratio, it is 1 widget per 2 thingamabobs or 1 thingamabob for .5 widgets.  Tangyland would not agree to this because domestically they can get 2.5 widgets for 1 thingamabob.  Timmyland would agree because domestically it takes 3 widgets to get a thingamabob.