Description
(20 pts) Suppose the world production possibility frontier (PPF) for cheese (X) andbread (Y) is given byX2+ 4Y2= 400,(1)and consumers preferences can be represented byU(X, Y) =XY.(2)(a) Graph the production possibility frontier (PPF) by plotting at least three numer-ical points on it.(b) Think about the general shape of the indifference curves, then on the same dia-gram use this information to show qualitatively where production and consump-tion will occur.(c) On the same diagram, show how the relative prices of cheese and bread will bedetermined.(d) Use the equations to compute the amounts ofXandYproduced and consumedand their relative prices. Check that these numbers and your diagram are gener-ally consistent.2. (20 pts) Consider a small economy trading with the rest of the world and taking worldprices as given. There are two goods in the world,XandY, with pricesPXandPY,and this country importsX.(a) Illustrate this situation on a PPF diagram (show where production and consump-tion take place). PutXon the x-axis.(b) Now the government puts a tariff onX: i.e. a tax on imports ofX. This will leadto a general rise in the domestic price ofX. Indicate on the diagram the changesthis will cause.(c) What did the tariff do to the welfare of consumers? Do you think the welfareof producers and/or of the government which is collecting the tariff revenue haschanged enough to offset this? Why or why not? To answer this, think aboutwhat we know generally about efficiency the answer is not in the diagram.
