ECON7073 Microeconomic Analysis - Free Samples to Students

The PPF is a curve representing the maximum possible production combinations of two goods in an economy. It means that production of cars cannot go beyond 30,000 even if zero bicycles were produced. Similarly, the production of bicycles cannot go beyond 6000 even if zero cars were produced. The PPF curve makes an assumption that the economy may decide to only one type of a product e.g. cars and ignore the production of the other good. The PPF also assumes that all the resources in the economy have been utilized to the maximum capacity. For this reason, it is assumed that the level outside the PPF curve are unattainable due to the constraint of resources. On the other hand, the area inside the PPF curve is attainable but an economy producing on such an area is considered inefficient as it represents underutilization of resources. It is also assumed that this curve is the same as the Marginal Rate of Transformation (MRT). The properties of the PPF curve are such that, it has a downward slope from left to right. This implies that, an increase in the production of one product e.g. cars, it’s at the expense of producing the other good (bicycle in this case). The opposite is true, when you produce more bicycles, you incur an opportunity cost of producing cars. The other property is that is has an increasing slope given its concavity to the origin. Lastly, all the points of combination along the PPF curve are considered to be efficient.

The first thing is to accept the fact that this combination is not attainable as it lies outside the PPF. This is the assumption that resources are scarce and that they have been utilized fully at the point of PPF curve. There are two possible combinations that can take place in this case. One, increase the production of cars from 18,000 to 20,000 but this would result in the production of bicycles falling from 3,000 to 2,700. The second combination would be to raise the number of bicycles production from 3,000 to 4,000 but this would cause the demand for cars to fall from 18,000 to 10,000. The solution would be to consider the opportunity cost of increasing the production of the other good and produce that with the lowest opportunity cost. If 4000 bicycles are produced, the production for cars declines by 8,000. However if 20,000 cars are produced, the production for bicycles declines by 300. The opportunity cost of producing bicycles is very high than that of cars production and thus it’s more efficient to produce 20,000 cars and 2700 bicycles. By producing Cars to avoid the high opportunity cost, Newland can import 1300 units of bicycles to meet the demand for bicycles also.

The second possible way is to increment in productive resources. This will raise the productivity capacity and the PPF will shift outward accommodating the increase in demand for both goods. The third possibility is to improve technology; for Newland to meet both demands, it should find cheaper ways of production such that the current resources can be able to produce more of these products; the PPF will shift outwards.

Q^D = 20 - 2p

Q^s = P – 1

At equilibrium, Q^D= Q^s

The imposition of $3 per Pizza is per unit tax

The price change will rise by the amount of tax, however, the rise will not be $3 above the equilibrium price. Tax incidence tells how much tax burden is borne by consumers and that borne by the producers. The elasticity of demand determines the tax incidence. When a product has an elastic demand, the highest tax burden lies on the producers and a small proportion is shifted to the consumers. Similarly, when a product has an inelastic demand, the highest tax burden lies on the consumers, and producers only carry a small proportion of the burden. The price will rise by $3 above equilibrium price only if the producer is able to shift the tax burden 100% to the consumers. Deadweight will result since there will be a loss in both surplus for the producer and for the consumer.

We start by calculating equilibrium P and Q

Q^D= Q^s

20 - 2p = P – 1

21 = 3P

P = 7

Since Q^D= Q^s, Q = either Q^Dor Q^s

Take Q^s = P -1 = Q

But P = 7, therefore Q = 7 – 1 = 6

Q = 6

Now we calculate the elasticity of demand (P_ed) and supply (P_es) to price changes given by the formula 

When P = 7 and Q = 6

P_ed given Q^D = 20 - 2p but   = -2

P_ed = -2 *  = -2.33

P_es given Q^s = P - 1 but   = 1

P_es = 1 *  = 1.17 

Now we find fraction of consumers and producers tax burden

Consumers’ tax burden

=

=

=  = -1.00

Producers’ tax burden

=

=

=  = 2.00

The initial quantity at equilibrium is Q^*, and is offered at price $250. At the price of $300, the demand falls from Q^* to Q₁. However, producers would like to supply Q₂ level of output at this high price and thus an oversupply equal to Q₂ – Q₁ occurs. The new equilibrium quantity Q₁ is lower and price is higher.

The government has fixed the price higher than the equilibrium price and thus many consumers cannot afford to buy the same units as before. Thus there is a loss in consumer surplus as the buy at price $300 other than $250. On the other hand, producers are happy now that their gains will improve by selling at $300 other than at $250. The loss in consumer surplus is the gain by the producers. The deadweight equal to triangle bdf occurs.

The oversupply will remain unsold. Producer surplus will fall since their willingness is to purchase at $250, but now they are forced to buy at $300. The total loss in consumer surplus is (300 – 250)Q₁ = 50Q₁. On the other side, there is a gain the surplus for the producers because they are willing to sell at $250, but now they have a chance of selling at $300. The gain is equal to (300 – 250)Q₁. The deadweight loss is area bdf

The outcome of the U.S. Bill is not fair as it is not producing fair results. The demand has fallen and consumers have a loss in surplus. This results in a gain in producer surplus, but this are not fair results given that there is an oversupply that remain unsold. The deadweight loss represents a welfare loss by the consumers. Even though the producers gain, they are not able to generate greater revenue due to the deficiency in demand. It is even possible that the profit made while selling Q₁ at $300 could be lower than selling Q^* at $250. This Bill could have been fair if the U.S. trade wheat internationally. The Bill is therefore hurting both the consumers and the producers. Or rather, if the producers are able to make the same level of revenue as before, the bill can be argued to make the consumers worse off without making the producers better off. Other policies need to accompany the Bill to generate some fair results, this could include the government buying the excess supply.

Supply of coffee will fall and the equilibrium supply curve S will shift to S₁ causing price to rise from P to P1. The supply shift to the right is because it’s induced by a non-price factor. The shortage is as observed above because suppliers need to supply Q₂ at price P_1.

Since there is still a shortage and supply remains to be S₁, an increase in demand will make the situation worse, price will rise further from P₁ to P₂. The shortage will seem severe because at price P₂ producers need to supply Q₄. The quantity demanded will fall further from Q₁ to Q₃.

Currently we are at S₁ the supply at shortage. Assuming that the trial of the new specie will be able to boost supply sufficient to push the economy back to the original supply level, S₁ will shift to the left to S, which is at the initial equilibrium. This is at a lower price level and a higher quantity level than when there was shortage. If the supply will be big enough to push supply beyond the initial equilibrium level, price will fall further. However, if the supply is not sufficient to push the market to original equilibrium price will fall between P and P₁ and quantity between Q and Q_1.

Bibliography

Anand, V, Production Possibility Curve under Constant and Increasing Costs. (Economics Discussion, 2018).

Gifford Adam, Tax Incidence: Definition, Formula & Example. (Studycom, 2018).

Hayes Adam, Economics Basics: Production Possibility Frontier, Growth, Opportunity Cost and Trade. (Investopedia, 2018).