ECO10250: Economics - Link between Scarcity, Choice & the Production Possibility Curve Assessment Answers

Assignment 1

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.

Question 1

• Explain the link between scarcity, choice and the production possibility curve. In your answer use graphs and include a description of the three concepts in your own words (300 words maximum).

The fundamental problem of economics deals with the issue of scarcity- where the resources are limited but human wants are unlimited. Scarcity occurs as we have to allocate the limited resources to satisfy unlimited human wants. As our wants exceed the resources available, we have scarcity in the economy. With the presence of scarcity, choices gave to be made as how best to allocate the available resources to satisfy our wants. Economics provide the best way to allocate the scarce resources in an efficient manner and thereby overcome the problem of scarcity. While making our choice, we have to consider the opportunity cost for our decision. Opportunity cost is the cost of next best alternative use. If we chose something, the next best alternative has to be foregone. The economic consequence of scarcity, choices and opportunity cost can be represented by the production possibility frontier. Production possibility frontier ( PPF) is a hypothetical representation of a curve that shows the maximum possible output that can be produced if an economy uses a set of given inputs ( Scarcity, choice and PPF, n.d) .

Let us assume, an economy, say Brazil can produce only two goods: clothing and soda. We further assume that Brazil can only produce 100,000 units of clothing and 50,000 cans of soda if it utilizes all available resources.

We have measured clothing in X axis and cans of soda in Y axis.

The production possibility frontiers for Brazil can be illustrated as follows:

Every point on the PPF is considered as the efficient point. But any point outside the PPF is known as the impossibility point because it is beyond the available resources. On the other hand , any point below the PPF is known an inefficient point because the economy can further reach to the efficient point by utilising more available resources.

• Outline the major factors that determine the type of economic system existing in a country. Based on the factors you noted above, describe the principal differences between the Australian economy and the Chinese economy (300 words maximum).

Nations across the world largely differ in their economic systems. Production, resource allocation exchange and distribution are some of the key factors that influence the economic system. In a pure market economy good and services are exchanged in a free market. Governments have a limited role in this economic system. Mixed economy is the economy where both private and government participate in economic activities. So government plays a significant role in the economic system of mixed economy. Third, in a pure command economy, government has the principal role: it decides what to produce and how much to produce. In other words, in a command economy government regulates the resources. This economic system is closely related to communalism and socialism. There is another economic system that is known as transitional economy where the economy has undergone structural reforms and intended to change from centrally planned economy to a market economy

Australia is characterized by a mixed market economy where the private enterprise and price mechanism works along with government regulation. In Australia, free market dominates in the economy with private ownership, price mechanism works with the profit motive of individual entrepreneurship. At the same time, government in Australia also control some of the services and redistributes the wealth (Carol Johnston & Mark Eggins, n.d)

On the other hand China’s economic system is the socialist market economy- it is a blend of the elements of socialism and capitalism. The economic system cannot be described as full blown socialist command economy. A lot of state or collective ownership is very much present in the economy at the same time China is certainly a strong market system. Due to this unique characteristic of Chinese economic system, economists refer them as “socialist market economy” (Barkley Rosser, 2015).

Question 2

1. There has been a breakthrough in the manufacturing of solar-powered motor vehicles that will substantially reduce their costs of production. Use demand and supply curves to illustrate what will happen to:
2. i) The equilibrium price and quantity of solar-powered motor vehicles.
3. ii) The equilibrium price and quantity of conventional motor vehicles.

i)In the above DD-SS graph, DD is the initial demand and SS is the initial supply curve for solar powered motor vehicle. The equilibrium price is P and the equilibrium quantity is Q.

Since the cost of production for solar powered motor vehicle has substantially reduced, their supply will increase in the market. As a result the supply curve for solar powered motor vehicle will shift to the right from SS to SS’ and the market will reach to a new equilibrium. At the new equilibrium point, the equilibrium price will come down from P to P’ and the equilibrium quantity for solar power motor vehicle will rise from Q to Q’.

ii) Conventional motor vehicles are the substitutes for solar powered motor vehicles. As the price for solar power motor vehicles has come down due to fall in cost of production, there will be a decrease in the demand for conventional motor vehicle. Many people will switch over to solar power motor vehicle as it becomes cheaper now. The demand curve for conventional motor vehicle will shift to the left. This is illustrated in the following demand – supply graph:

DD and SS were the initial demand and supply of conventional motor vehicle. Equilibrium price is P and the equilibrium quantity is Q. As more and more people will be incline to buy solar powered vehicle due to cheaper cost, the demand curve will shift leftwards from DD to DD. As a result the new equilibrium price for conventional motor vehicle will fall from P to P’ and the new equilibrium quantity will also come down from Q to Q’.

• In an attempt to increase the use of solar-powered motor vehicles the government decides to set a minimum price for solar-powered vehicles that is below the market price. Do you think this is a good idea? Explain your decision using graphs.

The government decides to set a minimum price for solar-powered vehicles that is below the market price then it must be considered as a price ceiling. In order to have an effective outcome, the price ceilings must be set below the equilibrium price. A price ceiling setting above the equilibrium price does not make any economic sense. Let Pc is the price set by the government. But at price Pc, demand will be at Q2 but the producers will be willing to supply only Q1. So there will be shortage of solar power vehicle at the market that can be represented by Q2Q1.

Thus setting a price for solar vehicle is not a good idea because it creates a shortage in the market (William A. McEachern, 2016).

Question 3

Explain what will happen to consumer and producer surplus and deadweight loss if the government imposes a tax on sellers for each radio they produce in order to raise government income? Include in your answer an explanation of the three concepts – consumer surplus, producer surplus and deadweight loss.

If the government impose the tax on sellers for each radio they produce, then their cost of production will increase. The supply curve for radio will shift upwards. The price will rise but how much the burden of tax will be shifted to buyers and how much to sellers, that completely depends on the elasticity of demand and supply curves. Let us illustrate the impact of excise tax on radio on the consumer surplus, producer surplus and the deadweight loss with the help of demand- supply diagram:

Due to imposition of excise tax on radio sellers the supply curve will shift to the left and the price will rise from P0 to P1. As the price increases, the consumers will be worse off – they have to pay higher price. So the consumer surplus will come down. Though the price has increased from P0 to P1, the producers are getting only P2 because of tax paid to the government. So the producers are also worse off and thus producer’s surplus will also come down. Since total surplus has dropped, there will be deadweight loss to the society. The deadweight loss is shown as the shaded triangle KLM in the above graph. The tax revenue will be (tax * new quantity) and can be shown as the rectangle of P1P2LK.

As far as the tax incidence is concerned, how much tax burden will be shared by the producers and how much will be by the consumers, that solely depends on the relative elasticity of demand and supply. If the demand curve is relatively inelastic as in the above figure, the consumers share the greater burden of the tax. But if the supply curve is relatively inelastic, then producers have to bear a greater burden of tax. In case of equal elasticity of demand and supply, the buyers and the sellers share the equal burden of tax (Bruce Domazlicky, n.d)

Question 4

The local cinema wants to increase its total revenue. It is considering the introduction of a 10% discount to locals. The company has estimated that there are two types of local customers who will have different responses to the discount offer. The likely responses of the two groups are shown in the table below.

i) Using the midpoint method, calculate the price elasticities of demand for Group A and Group B.

According to mid-point formula

Ed= [(Q2-Q1)/( Q2+Q1)/2] /[( P2-P1)/ ( P2+P1)/2]

For Group A (after 10% discount)

After the discount, price gas decreased by 10%

[(1.65-1.55)/( 1.65+1.55)/2] /(-0.1)

= - 0.625

Since the absolute value of elasticity is less than 1, the demand is inelastic for Group A.

For Group B,

[(1.70-1.55)/( 1.70+1.55)/2] /(-0.1)

=- 0.923076923

Since the absolute value of elasticity is less than 1, the demand is inelastic for Group B.

ii) Explain how the discount will affect total revenue from each group.

Since the demand is inelastic for both the groups, the discount or 10% reduction in price will not lead to increase the quantity demanded to a greater magnitude thereby reduce the total revenue.

iii) Should the company offer the discount if it wants to increase its total revenue.

In an attempt to increase the total revenue, the company must increase the price instead of offering a 10% discount.

An increase the price will lead to reduce the total revenue in a lesser magnitude, thereby increase the total revenue.

iv) Describe the impact on the demand elasticity for the original company when another cinema opens in the town.

If another cinema opens in a company then it will become a substitute for the original company. People will have another option to move to the new cinema in the town.

An increase in the number of substitute will increase the elasticity of the original cinema company.

Question 5

a) Complete the cost schedule below:

WE have used the following formulas:

TVC=TC-TFC

AVC=TVC/Q

AFC=TFC/Q

ATC=AVC+AFC

MC= Change in TC/Change in Q

P=AR=MR

• If the firm is operating in a perfect market where the price is $35 dollars how many units should this firm produce in order to maximise profit? Explain your answer.

Perfectly competitive firms are price takers and face a perfectly elastic demand curve

They determine the profit maximizing quantity at the point where P=AR=MR=MC

or P=MC

From the above chart, the prefect competitive firm will produce 7 units because at this level of output, P=MC=35