A Production Possibility Frontier or PPF shows the all possible combinations of output of two goods or services an economy can attain by employing all resources fully and efficiently.
The assumptions of a PPF are:
A typical PPF has two main characteristics:
In the above graph we see that based on the assumptions of PPF here too as the production of bicycles are increased, fewer units of cars are produced (Krugman, 2012).
(c) When Nevaland receives a demand of 4000 bicycles and 20000 cars, the combination of this output is beyond the production possibility frontier.
Any point out the PPF is impossible to achieve and can only be achieved when the economy experiences economic growth which would shift the PPF outwards. This would allow Newland to meet the demands.
Another alternative is that we can see Newland can produce only 10000 cars with 4000 bicycles. Hence to meet the increased demands of 20000 cars, Newland can import 10000 cars from foreign countries and produce 10000 itself.
It can also produce 24000 cars and 2000 bicycles out of which he exports 4000 cars for 2000 more bicycles.
Part II
|
Price (cents per bag) |
Quantity demanded (million bags per week) |
Quantity supplied (million bags per week) |
|
50 |
160 |
130 |
|
60 |
150 |
140 |
|
70 |
140 |
150 |
|
80 |
130 |
160 |
|
90 |
120 |
170 |
|
100 |
100 |
180 |
The demand and supply curve obtained is:
(a) As the graph shows the equilibrium quantity is around 145 million bags per week when the equilibrium price is around 62 cents where the two curves intersect. From the demand-supply schedule we see there is no equilibrium point where the quantity demanded is equal to the quantity supplied.
(b) The new dip increases the quantity by 30 million bags for each price. Hence, the demand supply schedule becomes as shown below:
|
Quantity demanded (million bags per week) |
Quantity supplied (million bags per week) |
|
|
50 |
190 |
130 |
|
60 |
180 |
140 |
|
70 |
170 |
150 |
|
80 |
160 |
160 |
|
90 |
150 |
170 |
|
100 |
130 |
180 |
Thus, as we see now, with increase in demand, the new equilibrium achieved in the potato chips market is at an equilibrium quantity of 160 million bags at an equilibrium price of 80 cents. At this point the quantity supplied is exactly equal to the quantity demanded which is 160 million bags per week. The new demand supply graph obtained is as shown below. D1 is the old demand curve and D2 is the new demand curve. As the demand at each price increases by 30 milllion bags we see that the demand curve shifts from D1 to D2 where higher amount of potato chips are available at the same prices (Mankiw, 2014).
(c) As the supply also increases by 40 million bags for each price we obtain the new quantity supplied as S2 in the demand-supply schedule below.
|
Price |
D1 |
D2 |
S1 |
S2 |
|
50 |
160 |
190 |
130 |
170 |
|
60 |
150 |
180 |
140 |
180 |
|
70 |
140 |
170 |
150 |
190 |
|
80 |
130 |
160 |
160 |
200 |
|
90 |
120 |
150 |
170 |
210 |
|
100 |
100 |
130 |
180 |
220 |
The graph obtained above is after the supply curve shifts from S1 to S2 indicating rise in quantity supplied. After both demand curve and supply curve shifts to D2 and S2 respectively, the new equilibrium quantity and price is achieved. At this new equilibrium the quantity demanded is equal to the quantity supplied of 180 million bags per week is when the price is 60 cents. Hence, when demand increases it leads to a rise in price and quantity, to meet the growing demand the supply also increase and combining both the shifts the overall quantity traded in the market increases and at a lower price.
(a) Initially Judy’s income was I1 = $130 which increased to I2= $170. The change in demand for her concert tickets was by 15% up.
Income elasticity of demand = Percentage change in quantity demanded/ Percentage change in
Income
Therefore percentage change in quantity demanded = 15%
Percentage change in income = [(170 – 130)/130]*100
= 0.308*100 = 30.8%
Therefore: income elasticity of demand = (15% / 30.8%) = 0.488
With increase in income Judy’s demand for bus rides go down by 10%
Income elasticity of demand for bus rides = Percentage change in quantity demanded/ Percentage
change in income
= -10% / 30.8% = -0.325
Demand for both bus rides and concert tickets are seen to be income inelastic because they are less than 1. For Judy, concert ticket is a normal good because with rise in her income her demand for concert tickets rises but bus rides are an inferior good for Judy because with increase in her income her demand for bus rides goes down (Sowell, 2010).
(b) The price of sushi rises by 5% and its quantity demanded falls by 1%. Therefore, the own price elasticity of demand for sushi is:
Own price elasticity of demand for sushi= Percentage change in quantity demanded/ Percentage
change in price
= -1% / 5% = -0.2
With 5% rise in the price of sushi the demand for soy sauce falls by 2%. Thus, the cross price elasticity of demand for soy sauce is:
Cross price elasticity of demand for soy sauce= Percentage change in quantity demanded of soy
Sauce / Percentage change in price of sushi
= -2% / 5% = 0.4
The negative elasticity indicates that sushi and soy sauce are complements because with rise in price of sushi, the demand for soy sauce also falls along with sushi.
(c) Price elasticity of demand for domestic beef is -1.30. The demand for domestic beef increases by 6.5% which is a result of a fall in the price of domestic beef. To find out the percentage change in price we use the formula for price elasticity of demand as follows:
Own price elasticity of demand = Percentage change in quantity demanded/ Percentage
change in price (Lipsey et al., 2011)
Therefore the price of domestic beef falls by 5% which leads to an increase in its demand.
To find the cross price elasticity of demand for imported beef with respect to domestic beef we use the formula as follows:
Cross price elasticity of demand = Percentage change in quantity demanded of imported beef/
Percentage change in price of domestic beef
= -4%/ -5% = 0.8
The elasticity of +0.8 indicates that domestic beef and imported beef are substitutes because with fall in price of domestic beef people reduce the demand for imported beef and substitute it with domestic beef.
QUESTION 3:
Part I:
|
Price (dollar per tonne) |
Quantity demanded (kilo tonnes) |
Quantity supplied (kilo tonnes) |
|
100 |
2000 |
0 |
|
150 |
1400 |
600 |
|
200 |
1200 |
800 |
|
250 |
1000 |
1000 |
|
300 |
800 |
1200 |
|
350 |
600 |
1400 |
|
400 |
0 |
2000 |
The demand supply schedule is given in the table above. On plotting this schedule we receive the demand supply graph as shown below:
As we see in this graph the equilibrium point where the quantity demanded is equal to the quantity supplied is at 1000 kilo tonnes at equilibrium price of $250 per kilo tonne.
The consumer and producer surplus is illustrated in the graph below where the region which is shaded red is the consumer surplus and the region shaded yellow is producer surplus.
Consumer surplus is the surplus which is generated on the consumer’s side whenever the price the consumer pays is less than what he/she is prepared to pay. Producer surplus refers to the gain of producers when the price received by them in the market is more than the minimum they would be prepared to supply for (Varian, 2010).
Economic welfare is the total benefit to the society from an economic transaction. Hence, it is the total of consumer surplus and producer surplus (Samuelson et al, 2010).
In this case as we see when the market is at equilibrium there is no generation of dead weight loss which represents a loss of economic efficiency.
But if the government decides to impose a price control such that the domestic price is set at $300 per tonne then there occurs a loss to both producers and consumers.
As we see in the graph above, as the government keeps a price floor it leads to a situation of excess supply where demand is less than the quantity supplied. At $300, the quantity supplied is 1200 but what is demanded is only 800. This leads to a fall in the producer surplus and the consumer surplus. As we see in the graph above, compared to the previous graph without any price floor, the consumer surplus decreases to the green region and the producer surplus is the blue region. The yellow shaded region is the loss of efficiency which is the deadweight loss because the market is not at equilibrium (Pindyck et al., 2009).
(b) Import quota is the limit on the amount of imports that can be brought inside a particular country. As Canada imposes the import quota on beef it limits the amount of imported beef to be brought into Australia.
In the diagram below we see the quota is the difference between the domestic supply and the domestic supply + quota. In the absence of quota the market price is Pworld and the import quantity is Q4-Q1. As an import quota of Q3-Q2 is imposed, the revenue of the domestic suppliers increase and the prices rise to Pquota. The supply of domestic producers increase to, Q1 to Q2. Thus now consumers face a higher price and the total quantity falls to Q4-Q3.
Due to the imposition of import quotas there occurs a net welfare loss to the society because the producer surplus increase is more than offset by the consumer surplus decrease. If not demand is too inelastic the world exporters are expected to make less revenue.
The free trade of imports and exports. If the importing country, which here is Canada imposes a quota of the amount as shown by the length of the red line, the price in Canada rises to the level where the import demand is equal to the quota level. Here we see that consumers in the domestic country suffer and lose out on the consumer surplus by –(A+B+C+D), due to the rise in price. Producers on the other hand experience an increase in well being because of the quota and their producer surplus is +A. Quota rents in the country accounts to an amount of +(C+G). The national welfare in the country is (G – (B+D)) which can be positive or negative.
(c) Australia being the exporting country, if its eports is much higher than the import quota set by Canda, the price in Australia will fall until its export supply is equal to the quota level.
As we see from the diagram above, Australia will face a welfare loss of (f+g+h). Its consumer surplus would be +e which shows that consumers will experience an increase in well-being because of the quota, whereas the producer surplus will be negative as –(e+f+g+h) as producers in the country will experience a fall in price. Hence, the country experiences a reduction in national welfare (Krugman, 2012).
(d) Korea’s equilibrium price for beef was $8 million per kilo tonne with equilibrium quantity 375 kilo tonne. In case of trade with no tariff, its domestic demand would be 625 kilo tonne and domestic supply would be 125 kilo tonne at the world price of $4 million per kilo tonne. The tariff rate that Korea currently imposes is 40% on all imported beef.
As we see in the diagram below, when there is no tariff the producer surplus is JFE whereas after tariff it is JDA. The area JFE is : (1/2 * (4-2) * (125-0)= 125.
Similarly, JDA is : (1/2 * (5.6 – 2) * 250)= 450
The producer surplus then would be 275 which is shown by the region in the graph denoted as 1.
Consumer surplus under no tariff is the area KIE and after tariff is KCA.
KIE = (1/2* (15-4)*(625-0)) = 3437.5
KCA =(1/2 * (15-5.6)*(500-0) )= 2350
Hence the consumer surplus is 2350 – 3437.5 = -1087.5 which is shown by (1+2+3+4).
The tariff revenue would be the area DCHG which is equal to (500-250)*(5.6-4) = 400.
Finally the deadweight loss would be : Producer surplus + tariff revenue – consumer surplus
= 275 + 400 – 1087.5 = -412.5
Hence the total dead weight loss is -412.5.
References
Pindyck, R, Rubinfeld, D & Mehta, P 2009, Microeconomics, Pearson, South Asia
Varian, H 2010, Intermediate microeconomics, Affiliated East-West Press, New Delhi
Samuelson, P& Nordhaus, W 2010, Economics, Tata McGraw Hill, New Delhi
Mankiw, G 2014, Economics: principles and applications, Cengage learning, New Delhi
Lipsey, R & Chrystal, A 2011, Economics, Oxford, New Delhi
Sowell, T 2010, Basic economics, Basic books, USA
Krugman, P 2012, International economics, Pearson , UK.
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