HI5003 Economics for Business: Production Possibility Frontier (PPF)

Answer to question 1 - Production Possibility Frontier (PPF)

Part A –

Position B: Point B lies inside the PPF which implies that resources are not fully utilized at this level. So, this point would be the point of inefficiency.

Point V: Point V lies on the curve. This means that the resources are being efficiently utilized and there is full employment. So, this level would be one of the efficient combinations.

Point D: This point falls above the curve. At this point, country Nepal cannot produce these goods with the help of given resources and technology. Point ‘D’ thus considered as unattainable production.

When 10,000 more rice are to be produced, the point would move from T to V. The rice production would increase by 10,000 units while the machinery production would reduce by 10 units.

So, the opportunity cost of 10,000 units of rice is 10 units of machinery

 

Part B –

B1) When fertilizers are being produced, that means the production of rice would increase because the fertilizers make crops more productive. So, this would rotate the PPF on X-axis, i.e., the axis where rice is market. It would rotate outward from there. In the graph, this is represented by PPF2 given PPF 1 is the original level.

B2) If there is a discovery of steel, then more raw material would be available to produce machinery. Hence the production of machinery would increase. This would mean a rotation of graph. So, the graph would rotate from ppf1 to PPF3, i.e., the shift outward would be shown only on Y axis that represents machinery.

B3) When funds are given in the country to increase production, they could hire more labor, buy more inputs. This increases the overall production and technological level of the country and shifts the whole PPF outside. So, the PPF shifts from PPF 1 to PPF 4.

Answer to question 2 - Markets in Action: Demand and Supply

Any surplus or shortage will arise due to the excess of supply or shortfall in demand. This excess and shortfall can be easily identified with the given figures of quantity demanded and supplied at respective prices.

Price

Demand

Supply

Shortage/Surplus

10

89

29

Shortage = 60

20

70

40

Shortage = 30

30

55

55

Equilibrium

40

39

67

Surplus = 28

50

25

80

Surplus = 55

60

11

95

Surplus = 84

 

At higher prices, producers supply more and thus create an excess supply. While, at lower prices consumers demand more, thus creating excess demand. The difference is shown in the above table as surplus or shortage accordingly.

 

Part A. Based on the table and graph, we can see that market equilibrium is at Price (per 10 kg bag) = 30 and Quantity = 55 (10 kg bags). In the graph, this is the point, where Demand and Supply curves intersect each other. At this, point, the market clears, and equilibrium is achieved.

Part B. Government often takes measures to reduce the prices of essential commodities such as rice. Thus, the essentiality of rice and its affordability for the poor is the primary factor that may motivate the government to reduce prices. In economic parlance, this is called Price Ceiling i.e. the stipulated price is the highest that the producer can see at.

Thus, if a price ceiling is set at $20 per 10 kg bag, then the rice market will have the following effects. The quantity supplied by suppliers will be 40 bags and the quantity demanded will be 70 bags. This is because a fall in price has increased demand from the buyers and reduced production from the producers. Thus, the market will be in disequilibrium, because there will be an excess demand of (70 - 40) bags that will remain unfulfilled.

Answer to question 3 - Price Elasticity of demand and supply

Based on the price elasticity of demand (E), the quantity consumption for an increasing price should be calculated first.

Q1 = 1,000, Q2 =?

P1 = 6, P2 = P1 × (1 + 0.25) = 6 × 1.25 = 7.5

E = -0.8; price elasticity of demand should be negative.

Hence by the formula as below:

E = [(Q2 – Q1) / {(Q1 + Q2) / 2}] / [(P2 – P1) / {(P1 + P2) / 2}]

-0.8 = [(Q2 – 1,000) / {(1,000 + Q2) / 2}] / [(7.5 – 6) / {(6 + 7.5) / 2}]

-0.8 = [(Q2 – 1,000) / (500 + 0.5Q2)] / [1.5 / 6.75]

-0.8 × (1.5 / 6.75) = (Q2 – 1,000) / (500 + 0.5Q2)

-0.1777 × (500 + 0.5Q2) = Q2 – 1,000

-88.85 - 0.08885Q2 = Q2 – 1,000

-0.08885Q2 – Q2 = - 1,000 + 88.85

-1.08885Q2 = - 911.15

 Q2 = 911.15 / 1.08885 = 837

Part A -

Total revenue (TR) at 6 price = Q1 × P1 = 1,000 × 6 = 6,000

Total revenue (TR) at 7.5 price = Q1 × P1 = 837 × 7.5 = 6,277.50

Since the elasticity of demand (0.8) is smaller than 1, price elasticity of the product is inelastic. This indicates a possibility of price rise, since this increases TR.

Sales or TR increases from 6,000 to 6,277.50 by the increase in price from 6 to 7.5. Therefore, the strategy of 25% price rise is justifiable. The management should adopt this strategy.

 

Part B –

The government can intervene in this market, since this is the market by which the government can earn tax revenue a lot without affecting the market much – Cigarette is a product that a smoker smokes because of their habit; therefore, a price change cannot change the habit. Demand of this product is almost remaining the same, indicating a good market for imposing higher tax for earning higher revenue by the government.

 

Answer to question 4 - Production costs

Total Revenue = ($400,000 + $190,000) = $590,000

Calculation of Total Expenses

Wages of 2 Cashiers = ($55,000 * 2) = $110,000

Pizza Ingredients = $50,000

Wages of 3 Pizza Bakers = ($60,000 * 3) = $180,000

Equipment = $10,000

Tuition Fees = $2,000

Manager = $75,000

Interest Paid = ($50,000 * 0.06) = $3,000

Accounting Profit = Revenue - Total Expenses

= $590,000 - ($110,000 + $50,000 + $180,000 + $10,000 + $2,000 + $75,000 + $3,000)

= $160,000

Salary Foregone = $80,000

Money withdrawn = $110,000, Interest foregone on withdrawn money = ($110,000 * 5%) = $5,500

Economic Profit = Accounting Profit - (Foregone salary + Foregone Interest)

= $160,000 - ($80,000 + $5,500) = $74,500

As Economic profit is positive, so there is no need to return to a teacher Job.

Answer to question 5 - Market Structure: Perfect Competition and Monopoly

Here, price is equal to marginal revenue. Also, the price is horizontal to the X-axis, which indicates that Sarah's farm is perfectly competitive. The farm is a price taker, that is it cannot manipulate the price level.

For a perfectly competitive firm, optimal or profit maximation condition is where its price is set equal to marginal cost, i.e.

Price = Marginal Cost

By the diagram, the point where marginal cost equates to price level is the optimal level of output and quantity where its profit is being maximized. Thus,

Optimal level of output= 500 bags of rice/ month.

The optimal level of price= AUD 40/20 kg bag

Profit is determined by the difference between total revenue and total cost or

Profit = (P-AC) × Q, where P= Price, AC = average cost and Q= quantity.

Here, P-AUD 40/20 KG, AC= AUD 34/20 KG, Q= 500 BAGS

Profit= (40-34) × 500= 6×500= AUD 3000/20 kg rice.

Key features of Sarah's farm with the perfect competitive market are-

(I) Price is perfectly elastic.

(II) Price is equal to marginal revenue.

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