Prof. Bryan Caplan

bcaplan@gmu.edu

http://www3.gmu.edu/departments/economics/bcaplan

Econ 311

Fall, 1999

1. Use the world-wide web or an encyclopedia to briefly (max 20 minutes) research the history of one invention. Then write a paragraph explaining (a) When the invention first appeared; (b) What previous technology, if any, it replaces; (c) The impact of the invention in living standards.
2. Using the Washington Post piece on the history of air conditioning: Air conditioning as we know it first appeared in 1902, gradually replacing the fan. You could also think of choice of location as a kind of technology: before air conditioning, people cooled themselves by avoiding living in the South. As the article describes, air conditioning has increased comfort during hot months, enhanced labor productivity in hot conditions, and cheapened building (which previously had to be designed to provide ventilation).

3. Draw supply and demand curves for wheat. What happens to price and quantity if demand for wheat rises? Falls?
4. If demand for wheat rises, the price and quantity of wheat rise. If demand falls, the price and quantity of wheat fall.

5. Draw supply and demand curves for (a) the original Mona Lisa and (b) an original finger painting by Maggie Simpson (the baby on The Simpsons). Pay special attention to the shape of the supply curves. Then explain: What happens to price and quantity if the demand for these paintings falls? Rises?
6. Both supply curves should be drawn as vertical. The difference is that the demand for the Mona Lisa is enormous and the demand for the Simpson painting is negligible. Thus, the Mona Lisa sells for \$30 M, while the Simpson painting might go for 10 cents.

If demand rises for either painting, quantity stays the same (1), but the price rises. If demand for either falls, quantity stays the same but the price falls.

7. Draw supply and demand curves for Aggregate Demand and Aggregate Supply. Does the AS curve look like the supply curve for wheat, or like the supply curve for the Mona Lisa? Why?
8. The AS curve looks like the supply curve for the Mona Lisa. The reason is that AS by definition includes all sectors of the economy; thus, when the price level rises, there is no "other" sector to provide additional resources. The original Mona Lisa, in contrast, has a vertical supply curve because it can't be reproduced.

9. Using AS-AD curves, diagram each of the following cases:
1. An increase in the money supply.

3. A decrease in the money supply.

5. The invention of the ATM.
6. AD increases (due to the fall in money demand).

7. Easier bankruptcy laws makes banks unwilling to issue credit cards to bad credit risks.
8. AD decreases (due to the rise in money demand).

9. Workers get lazier.
10. AS decreases.

11. Scientists figure out how to make better computers.
12. AS increases.

13. Consumers rent fewer videos and go to more movies instead.

No change - this is a shift in the COMPOSITION of AD, not a shift of AD overall.

1. Using AS-AD curves, diagram the impact of economy-wide price maxima. In 2-3 sentences, explain what happens.
2. The dashed horizontal line shows the maximum price level. At this price level, AD exceeds AS, so there are economy-wide shortages. Expect economy-wide lines, corruption, and black markets.

3. Using AS-AD curves, show what happens if the government imposes an economy-wide price maxima at the equilibrium price level. (Hint: This part is easy). Then diagram and explain what happens if AD increases and the government leaves the legal price level unchanged. (2-3 sentences)
4. The dashed horizontal line shows the maximum price level. Initially, there is no effect. After AD increases, however, the usual shortages emerge. The lesson: price controls may appear to do no harm at first, but have increasingly bad consequences if AD continues to increase after price controls are imposed.

5. Is a decline in AD inflationary or deflationary? What about an increase in AS? (2-3 sentences)
6. A decline in AD is deflationary, of course; it makes the equilibrium price level fall, and this process of falling is deflation. An increase in AS is also deflationary; the equilibrium price level falls, and again the process of falling is deflation.

7. Explain why and how AS shifts affect the production possibilities frontier, but AD shifts do not. (3-4 sentences)
8. If AS shifts, the total quantity of output that can be produced rises. Suppose your PPF shows two goods. Then the AS shift makes it is possible to supply more of both goods. In contrast, the shift in AD merely raises the price level without increasing output. Since the AD shift does not change total output, the PPF cannot have shifted.

9. Suppose the money supply doubles. What happens to the price level and inflation? Does one, the other, both, or neither change permanently? (2-3 sentences)
10. AD increases, but it is a one-time increase. The price level permanently doubles, since the nominal quantity of money is twice as large as before. During the transitional period, inflation increases as the old price level moves to its new position. But once you reach the new equilibrium price level, inflation stops; the inflation is only temporary.

11. Fred has taken the classes in the table below. Compute his GPA:
12.  Class Units Grade English comp 3 B (3.0) calculus 4 C (2.0) statistics 3 B (3.0) intro econ 3 A (4.0)

GPA=(3*3+4*2+3*3+3*4)/(3+4+3+3)=38/13=2.92.

13. The steel industry produces four kinds of steel. Compute the TSI (Total Steel Index):
14.  Product Quantity (million tons) Index Weight grade AAA steel 100 .4 grade AA steel 150 .3 grade A steel 120 .2 scrap 300 .1

TSI=(100*.4+150*.3+120*.2+300*.1)=139. Note that if the index weights did NOT add up to 1, we would need to divide (100*.4+150*.3+120*.2+300*.1) by the sum of the weights.

15. In one paragraph, explain a conceptual problem with GDP, and suggest a alternative definition that adjusts for the problem. If your alternative definition were used, would measured GDP be bigger or smaller?
16. One conceptual problem with GDP is that it does not count black market activity. An alternative definition would estimate black market GDP using anonymous interviews and surveys, then add it to standard GDP figures. Clearly this would tend to increase measured GDP, since it would add a positive quantity to the standard definition.

17. Provide a modernized example of one of the fallacies Bastiat critiques. What would Bastiat say about it? (1 paragraph)
18. After the recent hurricane, many commentators described it as a benefit for the local economies. Bastiat would point out that this is confusing effort and result: True, the hurricane may increase the effort people apply in enriching themselves. But at best this effort will only get people back to the same situation they were at prior to the hurricane.

19. Use an AS-AD diagram to explain the effect of permitting free immigration from Mexico. Explain your answer (2-3 sentences)

AS increases for several reasons. The simplest is that the quantity of labor increases: more people can produce more. But more importantly, this extra labor frees up U.S. workers for more productive activities. For example, some U.S. families will be able to hire nannies from Mexico, which will permit more U.S. mothers to work in their trained professions. There is no need to draw two diagrams (one for the U.S., one for Mexico), but if you did, you should show that due to this second effect, output in the U.S. increases by MORE than it decreases in MEXICO.