Production Possibility Frontier, Basic Problem Of Economy, Economic Systems, Equilibrium In Market, And Price Floors

Production Possibility Frontier

1. a)Production Possibility Curve (PPC) that captures output capacity of  the nation is usually concave in shape.  The curve is drawn taken the axiom possible combination of output devoting all the resources of the country.  The amount of resources in an economy is constant. Therefore, the country cannot produce unlimited quantity all goods. In fact, increase in output of any one commodity involves the choice of sacrificing other commodity (Nicholson & Snyder, 2014). This is termed as opportunity cost associated with the production choice. Now more the country produce one good the more it needs to sacrifice other commodities. The presence of increasing opportunity cost make the PPC bowed outward.  On a straight line, the opportunity cost remains constant, which is not actually the case. 

Figure 1: Production possibility Curve of a nation

(Source: as created by Author)

The above figure describes the production possibility frontier of a nation assuming the economy produces only two goods X and Y. Increase in production of X from X* to X** involves decrease in consumption of Y from Y* to Y**.

b) The basic problem of the economy is limited means and unlimited wants. This creates scarcity problem in the economy (Krosch & Amodio, 2014). People always have to sacrifice some choice to opt some their choice. It is not about the problem of a single economic agent. Rather it is the problem of the whole economy. Jane who was unemployed for nearly a year may suffer from the problem of monetary scarcity. When Jane gets a high paying job it may solve his monetary problem but cannot solve the choice problem. Thus, he never gets rid off the problem of economic scarcity.

c) Every economy operates in a way such that is can minimize the scarcity problem. The economy tries to optimum decision that will lead to efficient allocation its scarce resources. In some economy the economic decision is taken by a central power while in some other it is left on free market economy (Koo & Perkins, 2016). The economy where the central power exists and takes decision on behalf of economic agents is known as socialist economy. In economy where different economic agents as consumers and producers take independent decision to maximize, their welfare is called capitalist or free market economy. In addition, there can be a combination of these two types of economy known as mixed economy.

Basic Problem of Economy

Economic system refers to the management of production, consumption and distribution of goods and services in the economy. The economy in the United States is an example of mixed economy. In US, there are both public and privately owned enterprises (Sutton, 2017). The government controls resource allocation in public sectors and controls the necessary production of the economy. Food stamps are provided people to meet their need for food demand.  In order to fulfill the basic needs of the people with scarce resources government grants aid for house, health and other benefits. For other sector, the economy relies on free market economy for efficient resource allocation.

2. a)

Figure 2: Demand and Supply Schedule of ice cream

Equilibrium price and quantity in the market is $2 and 7 ice cream respectively.

Consumer surplus is the gain to the consumers. It is computed as a difference between maximum willingness to pay for a good and the existing price of the commodity. There are two price beyond the equilibrium where the consumers still demand ice cream reflecting a higher willingness to pay. Therefore, Consumer surplus in the ice cream market is-

Producer Surplus is the gain to the producers for participating in market activity. As like consumer surplus it is obtained by king away the minimum price at which the producers ready to supply a good from the market equilibrium price of the good (Carlton, & Perloff, 2015).. The suppliers who are willing to supply the good at below the equilibrium price receive producer surplus. 

Figure 3: Demand and Supply for ice cream in winter

 Demand for a commodity depends on a number of factors. Price is the major determinant of demand, Change in price causes a shift point of quantity demanded on the demand curve. The inward or outward shift of the demand curve happens for factors other than prices (Rios, McConnell & Brue, 2013). One such factor is taste and preference for the concerned commodity. In winter people has less preference for ice cream. This causes a decrease in demand as presented by the inward shift of the demand curve. The equilibrium is obtained at the intersection of new demand curve and old supply curve. In the new equilibrium both the price and quantity demanded for ice cream will be reduced.

Economic Systems

With a shift in the equilibrium point, surplus enjoyed by both the consumers and producers will change. Consumer surplus depends on equilibrium price and willingness to pay. Both is reduced in winter as compared to in summer. However, decrease in willingness is greater than decrease in equilibrium price. Therefore, consumers in the ice cream market experience a reduction in consumer surplus. A reduction in equilibrium price along with change in the willingness to supply reduces producer surplus as well.

3. i)Price floor is a government interventionist measure to regulate price. In times of too low market price government takes the support price policy (Case, Fair & Oster, 2014) The effect the policy is explained in the following diagram. 

Figure 4: Price floor policy in the market for milk

(Source: as created by the Author)

The demand and supply curve in the milk market is expressed by the curve DD and SS respectively. Without any intervention price is P* and quantity sold in the market is Q*. Now suppose government sets a price floor, which sets the market price at Pmin. At the increase price consumes decreases their demand whereas suppliers increase their supply. Consumers demanded Qd amount of milk whereas in the market thee available supply is Qs.

ii)Price floor increase the price in the market. A higher price for the product increases revenue earn from per unit of the product. This is likely to increase their income f it is possible to sell all their product at the prevailing market price. Consumers in response to high price by shrinking their demand as much as possible. Thus, fulfilling only the existing demand cannot assure the farmers with an increased income.

iii) In order to assure the dairy farmers an increased income, government should purchase the excess supplied quantity from the farmers. This costs heavily to the government. Government can store this to the buffer stock. However, for non-durable goods like milk it is nit possible to store for a long time. Thus, the government has to destroy it or sell it at a low price to elsewhere. This ultimately causes a huge loss to the government. Therefore, it may not be a good decision to purchase the entire surplus product. However, it increases income of the dairy farmers but ultimately is results in a deadweight loss as net cost exceeds net benefit.

 4. a)

 b) In times of holiday, people willing to pay a high price for ticket fare. This is the time, when people ready to pay beyond their budgets. In off-season, people book air ticket less because of the high price. In holiday seasons, if airlines companies slightly adjust their price then demand can be increased at a rapid pace. This makes the demand for airline tickets highly elastic to price reduction.

5. a)

b) For a perfectly competitive market, profit maximization condition suggests that price equals marginal cost (Currie, Peel & Peters, 2016). If price is $20 the sellers in the market will produce up to point where marginal cost equals $20. Form the table, when the gardening company produces 5 unit of products then its marginal cost $20. Therefore, the company should do 5 gardens to maximize profit. 

Figure 5: Average variable cost, Average total cost and Marginal cost 

Figure 6: Marginal Revenue curve

(Source: as created by the Author)

References

Carlton, D. W., & Perloff, J. M. (2015). Modern industrial organization. Pearson Higher Ed.

Case, K.E., Fair, R.C. & Oster, S. (2014). Principles of economics. Pearson Higher Ed.

Currie, D., Peel, D., & Peters, W. (Eds.). (2016). Microeconomic Analysis (Routledge Revivals): Essays in Microeconomics and Economic Development. Routledge.

Koo, B. H., & Perkins, D. H. (Eds.). (2016). Social capability and long-term economic growth. Springer.

Krosch, A. R., & Amodio, D. M. (2014). Economic scarcity alters the perception of race. Proceedings of the National Academy of Sciences, 111(25), 9079-9084.

Nicholson, W., & Snyder, C. M. (2014). Intermediate microeconomics and its application. Cengage Learning.

Rios, M. C., McConnell, C. R., & Brue, S. L. (2013). Economics: Principles, problems, and policies. McGraw-Hill.

Sutton, C. (2017). Introduction. In Britain’s Cold War in Cyprus and Hong Kong (pp. 1-14). Springer International Publishing.

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