1393AFE Economics for Decision Making: Production Possibility Curve
Questions:
Note that when you are answering questions that require mathematical calculations, you should provide details as to how the answers were derived. In completing your answers, you should use graphs wherever possible. Always provide a brief explanation of each graph, including how it relates to your overall answer/argument.
1.
- Explain why a production possibility curve is usually bowed outward rather than being a straight line.
- Jane has been unemployed for nearly a year but finds a high-paying job with an international hotel firm. Does this mean that Jane will no longer experience the problem of ‘scarcity’? Explain the reasons for your answer.
- Every country has an economic system that has been established to address the problem of scarcity. Describe the economic system of a country other than Australia. Justify your assessment of the system by considering the major factors that determine an economic system within a country
2.
- The table below shows the demand and supply for ice creams.
|
Price of an ice cream ($) |
Quantity demanded (‘000) |
Quantity supplied (‘000) |
|
0.00 |
19 |
0 |
|
0.50 |
16 |
0 |
|
1.00 |
13 |
1 |
|
1.50 |
10 |
4 |
|
2.00 |
7 |
7 |
|
2.50 |
4 |
10 |
|
3.00 |
1 |
13 |
- Graph the following demand and supply schedules.
- What is the equilibrium price and quantity in this market for ice creams?
- Calculate the consumer surplus and producer surplus at the equilibrium in this market.
- Assume that the demand schedule for ice creams outlined above is for summer. What do you think will happen to equilibrium price and quantity for ice creams during winter? Explain the reason for your answer.
- What do you think will happen to consumer and producer surplus as a consequence of the change in equilibrium price and quantity for ice creams during winter? Explain the reason for your answer.
3.
The government has decided that the free-market price for milk is too low.
- In an attempt to help dairy farmers increase their income the government imposes a price floor in the milk market. Use demand and supply diagrams to illustrate the impact of this policy on the price of milk and the quantity sold as well as the state of the market.
- Can dairy farmers be assured of an increased income? Explain your answer.
- Would it be a good decision for the government to purchase all the surplus product? Explain your answer.
4.
- Complete the table below. In your calculations use the midpoint methodto calculate the price elasticities.
|
Price ($) |
Quantity demanded |
Total revenue ($) |
Percent change in price |
Percentage change in quantity demanded |
Elasticity |
Assessment of Elasticity |
|
2 |
10 |
20 |
|
|
|
|
|
3 |
8 |
24 |
|
|
|
|
|
4 |
6 |
24 |
|
|
|
|
|
5 |
4 |
20 |
|
|
|
|
- During a holiday period do you think the price elasticity of demand for airline tickets would be the same as in the off-season or would it become more elastic or more inelastic? Explain your answer.
5.
- a) Complete the cost schedule below for a gardening company:
|
Quantity of gardens |
Total Fixed Cost (TFC)
$ |
Total Variable Cost (TVC) $ |
Total Cost (TC)
$ |
Marginal Cost (MC)
$ |
Average fixed cost (AFC) $ |
Average variable cost (AVC) $ |
Average total cost (ATC) $ |
|
0 |
10 |
|
10 |
|
|
|
|
|
1 |
|
|
14 |
|
|
|
|
|
2 |
|
|
22 |
|
|
|
|
|
3 |
|
|
34 |
|
|
|
|
|
4 |
|
|
50 |
|
|
|
|
|
5 |
|
|
70 |
|
|
|
|
|
6 |
|
|
94 |
|
|
|
|
|
7 |
|
|
122 |
|
|
|
|
|
8 |
|
|
154 |
|
|
|
|
- If the firm is operating in a perfect market where the price for gardening at one house is $20 dollars, how many gardens should this company do in order to maximise profit? Explain your answer.
- Graph the average variable cost, average total cost and marginal cost and marginal revenue curves.
Answers:
1.
A PPC (Rittenburg & Tregarthen) is bowed out due to increasing opportunity costs of producing a good. Consider X and Y.
This means that to produce more of X we must reduce Y as our resources are fixed. We have to move from point A to B. To produce 1 more X, we have to pull out resources ( like labor ) from Y and put them into factories for X. We reduce Y as shown by red line as we move from A to B to get 1 more unit of X. As we move from B to C we still get 1 more X unit but we need to give up more Y now, as shown by green line.
Thus we give up more and more of Y to get 1 unit more of X. This is why we cal this increasing opportunity costs of butter.
This happens because inputs like labour are not equally efficient at producing X and Y. Each input will be efficient at producing any one good, which gives comparative advantage to production of that good.
b.
Scarcity is a macro issue, from the economy level. It means that jobs available are lesser than the no of persons who are looking for work. For each person who has a job there is no scarcity as long as he has a job. For someone who is unemployed there is scarcity of jobs.
As long as Jane has a job she does not face scarcity. If unemployed there is scarcity of jobs for her.
c.
Consider India as a country. When it became free of British colonial rule in 1947 it adopted mixed economy model of an economic system. It allowed some sectors to have private producers but reserved many sectors for State production only- defence, heavy machines, etc. This was done as resources were scarce and the needs of a poor nation were manifold. It was thought that State allocation of resources is best to overcome the scarcity problem.
India first policy - Industrial Policy of 1948 was framed under the mixed economy concept, allowing a role for private and public sector. It was followed by Industrial Policy 1956. IT clearly came out in favour of wide spread State involvement in industrial activities. 17 industries were made the exclusive domain of State. No private sector was allowed in these industries- arms and ammunition, atomic energy, iron and steel, heavy castings and forgings of iron and steel, heavy machinery, heavy electrical industries, coal, mineral oil, mining; iron ore and other important minerals like, copper, lead and zinc; railway transport, aircraft, ship building, telephone, telegraph and wireless equipment, and generation and distribution of electricity. (Jadhav, n.d.)
This policy was later reversed in 1991, when India embarked on reforms. The cause of this change was the difference in economic strenght of India in 1947 and 1991. In 1947 India was poor and under developed- with scarce resources- financial and non financial. It needed to build on its limited resources to grow. By 1991 India was better placed and had built up certain basic industries and started deregulating many industries. The process of privatisation was made possible due to availability of more resources that were better and more efficient than those in 1947. (Home.fau.edu, n.d.)
This is clear case of resource availability dictating the economic system adopted by a nation.
2.
|
Price of an ice cream ($) |
Quantity demanded (‘000) |
Quantity supplied (‘000) |
|
0.00 |
19 |
0 |
|
0.50 |
16 |
0 |
|
1.00 |
13 |
1 |
|
1.50 |
10 |
4 |
|
2.00 |
7 |
7 |
|
2.50 |
4 |
10 |
|
3.00 |
1 |
13 |
i. Graph the following demand and supply schedules.
ii. What is the equilibrium price and quantity in this market for ice creams?
P = $2 and Q= 7000
iii.
We need P when DD is zero. This will happen when P = 3.33 using the logic given in the table ( for every $0.5 change in price demand changes by 3 units)
Consumer surplus = ½ *( 3.33-2) *7000 = 4655
Producer surplus = ½ *( 2-0.5) *7000 = 5250
iv.
In winters the demand for ice cream is likely to fall. This is shown as a left shift of the DD. This will cause price and quantity to fall. The assumption is that there is no change in supply or any other demand determinant ( like income and consumer preferences). The lwinter demand is to left of original demand so that equilibrium price and quantity is lower.
v.
As the price falls in winters, we can expect consumer surplus to rise. However the fall in quantity must not be larger than fall in price. This is because consumer surplus depends on price and quantity. In general price decline leads to higher consumer surplus, but we still need to check the fall in quantity.
If consumer surplus rises we expect producer surplus to fall. This is because total welfare = sum of consumer and producer surplus. An exact answer needs data on the extent of decline in demand in winters.
3.
The government has decided that the free-market price for milk is too low.
i.
We start with demand curve DD and supply curve SS so that equilibrium price is P* and quantity is Q*. The government imposes floor that is above P*, as this equilibrium price is deemed low. At Pf the demand equals Q1 while supply is Q2. This means that we have excess supply or surplus = Q2-Q1. Now only Q1 amount will be exchanged in the market. This is lower than Q* but the price realised will be higher. Some sellers will be worse off as they are unable to sell at Pf, since there is not enough demand.
ii.
Some farmers who are able to sell at Pf will get Pf instead of P*. The effect on income will depend on exact values, which is based on demand and supply elasticities. Some farmers will surely be worse off as they are unable to sell an amount equal to Q2-Q1.
The effect on total incomes to all farmers will again depend on the difference between P* and Pf, as well as elasticites.
iii.
It will be good for the farmers as all those willing to sell at Pf will be able to sell. The total incomes of all farmers will surely go up. This is because price ( Pf) and quantity ( Q2) are both higher as compared to P* and Q*.
From a macro view, this may cause imbalances in government budgets as this expenditure is base on an artificial price floor level which has no rationale.
4.
a. Complete the table below. In your calculations use the midpoint methodto calculate the price elasticities.
|
Price |
Quantity demanded |
Total revenue |
% change in price |
% change in quantity demanded |
Elasticity |
Assessment of Elasticity |
|
2 |
10 |
20 |
- |
|
|
|
|
|
|
|
2.5 |
9 |
|
|
|
3 |
8 |
24 |
0.4 |
-0.222 |
-0.556 |
inelastic |
|
|
|
|
3.5 |
7 |
|
|
|
4 |
6 |
24 |
0.285 |
-0.285 |
-1 |
unitary elastic |
|
|
|
|
4.5 |
5 |
|
|
|
5 |
4 |
20 |
0.222 |
-0.4 |
-1.8 |
elastic |
b. During a holiday period do you think the price elasticity of demand for airline tickets would be the same as in the off-season or would it become more elastic or more inelastic? Explain your answer.
One factor that affects elasticity is the number of options available with the consumer.
In the off season people have no burning desire to go for a holiday- they are accepting of other options like sitting home or going to local places. In the non off season, people want to go far away, which means they need to fly. There is no other option of reaching the tourist destinations, this means that demand is more inelastic in non off season or peak season. In the off season demand is elastic as people have other options that do not need air travel.
5.
|
Quantity of gardens |
Total Fixed Cost (TFC) |
Total Variable Cost (TVC) |
Total Cost (TC) |
Marginal Cost (MC) |
Average fixed cost |
Average variable cost |
Average total cost |
|
|
$ |
|
|
(AFC) |
(AVC) |
(ATC) | |
|
$ |
|
$ |
$ |
$ |
$ |
$ | |
|
0 |
10 |
|
10 |
|
|
|
|
|
1 |
10 |
4 |
14 |
4 |
10 |
4 |
14 |
|
2 |
10 |
12 |
22 |
8 |
5 |
6 |
11 |
|
3 |
10 |
24 |
34 |
12 |
3.3333 |
8 |
11.333 |
|
4 |
10 |
40 |
50 |
16 |
2.5 |
10 |
12.5 |
|
5 |
10 |
60 |
70 |
20 |
2 |
12 |
14 |
|
6 |
10 |
84 |
94 |
24 |
1.6667 |
14 |
15.667 |
|
7 |
10 |
112 |
122 |
28 |
1.428 |
16 |
17.428 |
|
8 |
10 |
144 |
154 |
32 |
1.25 |
18 |
19.25 |
b.
The logic used is MR= MC
As price is fixed the P= MR = 20
MC is shown in table.
At Q = 5 MR=MC = 20
This is equilibrium output level where profits are maximum .
Profits = TR-TC = 20*5 – 70 = 30
c. Graph the average variable cost, average total cost and marginal cost and marginal revenue curves.
Bibliography
Courseera.org, n.d. MR=MC rule. [Online] Available at: HYPERLINK "https://www.coursera.org/learn/principles-of-microeconomics/lecture/zKD8R/pricing-and-production-rules-p-mr-mc-the-shutdown-rule" https://www.coursera.org/learn/principles-of-microeconomics/lecture/zKD8R/pricing-and-production-rules-p-mr-mc-the-shutdown-rule [Accessed 2 August 2017].
CSun.edu, n.d. Microeconomics. [Online] Available at: HYPERLINK "https://www.csun.edu/sites/default/files/micro3.pdf" https://www.csun.edu/sites/default/files/micro3.pdf [Accessed 2 June 2017].
Econ.ohio-state.edu, n.d. Elasticity. [Online] Available at: HYPERLINK "https://www.econ.ohio-state.edu/jpeck/H200/EconH200L5.pdf" https://www.econ.ohio-state.edu/jpeck/H200/EconH200L5.pdf [Accessed 30 May 2017].
Econport.org, n.d. Impact of Shifts in demand and supply. [Online] Available at: HYPERLINK "https://www.econport.org/content/handbook/Equilibrium/Impact-.html" https://www.econport.org/content/handbook/Equilibrium/Impact-.html [Accessed 3 June 2017].
Gallo, A., n.d. A refresher on price elasticity. [Online] Available at: HYPERLINK "https://hbr.org/2015/08/a-refresher-on-price-elasticity" https://hbr.org/2015/08/a-refresher-on-price-elasticity [Accessed 15 August 2017].
Home.fau.edu, n.d. Indian Economy since Independence. [Online] Available at: HYPERLINK "https://home.fau.edu/sghosh/web/images/India%20talk.pdf" https://home.fau.edu/sghosh/web/images/India%20talk.pdf [Accessed 15 Aug 2017].
Jadhav, N., n.d. Industrial Policy since 1956. [Online] Available at: HYPERLINK "https://www.drnarendrajadhav.info/drjadhav-data_files/Published%20papers/Indian%20Industrial%20Policy%20Since%201956.pdf" https://www.drnarendrajadhav.info/drjadhav-data_files/Published%20papers/Indian%20Industrial%20Policy%20Since%201956.pdf [Accessed 15 Aug 2017].
Rittenburg, L. & Tregarthen, T., n.d. Principles of Economics V 1.0. [Online] Available at: HYPERLINK "https://catalog.flatworldknowledge.com/bookhub/22?e=rittenecon-ch02_s03" https://catalog.flatworldknowledge.com/bookhub/22?e=rittenecon-ch02_s03 [Accessed 14 August 2017].
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