Production Capacity, Market Equilibrium, And Elasticity Of Demand And Supply

Potato Chips: Market Equilibrium and Elasticity of Demand

Q 1:

1. The production posibility frontier (PPF) for NewLand  is shown below with cars on Y axis and bicycles on X axis.
2. A production posibility frontieris defined as ‘the locus of combinations of two goods that can be produced in an economy with available resources and technology’. It assumes :

• Limited and fixed levels of available resources.
• Technology is given and does not change.

Using the given table of production possibilities we may note the following:

• The production posibility frontier shows the maximum level of production possible. A point on the PPC like A represents productive efficiency in the economy. At A all resources are fully utilized.  
• Productive inefficiency exists at all points that lie inside PPF, like B. It shows that we can shift from B to A, producing more of both cars and bicycles as resources are lying unused.  
• A point like C that lies outside the PPC is impossible with given resources and technology.
• The shape of the given PPC is concave to the origin, or it is shaped like a bow. This indicates that the  opportunity cost of making bicycles is increasing. A straight line PPC shows constant opportunity cost.  

We possibility of producing 400 bicycles and 2000 cars is shown below. The point that represents this combination does not lie on the PPC. It is like the point C above. To reach this point the PPC has to shift out.

The outward shift of the PPC is possible with better technology, more resources, higher productivity level of resources, or a combination of these:

1. An increase in level of available resources. For example, if more women are willing to work then it adds to the labour force.
2. A rise in productivity of resources will shift PPC outwards. Such a rise in possible with training facilities for labour.
3. New and better technology can also lead to C. This will allow the existing resources to produce more of both goods.

Part 2

1. Equilibrium is where demand curve D1 intersects meets the supply curve S1. As shown equilibrium price= $65 and quantity= 145 million bags per week.
2. The ADDITION IN demand is depicted as a rightward shift of the demand curve, where the direction is highlighted by the arrow. The intersection of D2 and S1 is the new equilibrium with price =$80 and quantity= 160 million bags per week.

Now the addition to supply is depicted by shifting the supply curve down, as the arrow shows the direction. The new equilibrium is determined by the intersection of D2 and S2, with equilibrium at price =$ 60 and quantity= 180 million bags.

Q2:

1. Income elasticity of demand for concert tickets  = % change in demand/ % change in income

We calculate % change in income as  100*( new income – old income) /old income

= 100* ( 170-130)/ 130 = +30.76% or 30%( after rounding off)

So income elasticity of demand for concert tickets = +15%/+30% = 0.5 = ½ .    

Concert tickets are a normal good as the sign is positive.

 Income elasticity of demand for bus rides  = % change in demand/ % change in income

From given data this is =  -10%/+30% = -1/3 =  -0.33

Bus rides are found to be an inferior good-  as  shown by the negative sign of income elasticity.

1. As per definition, Price elasticity of demand for sushi   

= % change in demand for sushi / % change in price of sushi

= -1%/+5%= -1/ 5 = -0.2. As this  value is less than 1 in absolute terms demand is said to be inelastic.

Cross price elasticity of demand for soy sauce with respect to the price of sushi is equal to.

= % change in demand of soy source/ % change in price of sushi

= +2%/+5% = 2/5 = 0.4.

A positive value of cross elasticity shows the two goods are gross substitutes. Sauce replaces/ substitutes for sushi as price of sushi rises.

1. Elasticity of demand for domestic beef is defined as the ratio of % change in demand for beef to  % change in price. This is given as  -1.3

A simple mathematical manipulation will show that

% change in domestic price =% change in demand for beef/ price elasticity of demand

=  +6.5 %/-1.3 = – 5%  or 5% fall in price.

Cross price elasticity of imported beef with respect to domestic beef

= % change in demand for imported beef/ % change in domestic price =  -4 %/-5% = 4/5 = 0.8

 A positive sign shows that they are gross substitutes of each other. Consumers substitute imported beef for domestic beef when the price of domestic beef rises.  

Beef: Elasticity of Demand and Import Quota

Q3 :Part1

Ina free market equilibrium is where demand equals supply at E -price = $250 per tonne and quantity = 1000 kilo tonnes. When a price floor is applied we can see that price is now fixed at $300. At this level there is an imbalance between demand and supply. Demand is 800 while supply is 1200. This gap is called SURPLUS  =  1200-800=400 kilo tones.  Producers want to sell 1200 kilo tones but are able to sell only 800 kilo tonnes anges in welfare, measured in terms of consumer surplus and producer surplus can be shown using the different regions marked below. These regions can also be evaluated numerically.

Before any price control consumer surplus is orange area, and green area is producer surplus.

After the control is in place we can show that consumer surplus is now only A, but it was A+B+E earlier. It has reduced by B+E

Producer surplus has risen to B+C+D, from C+D +F earlier. The change is shown as B-F.

Deadweight loss = sum of changes in consumer and producer surplus = B-F +(-B-E)= -E-F ( as shown in blue  

We now solve the areas shown numerically

A :  ½ *(400-300)*800 = 40000

B: (300-250) *800 = 40000

C:  (250-200)*800= 40000

D:  ½ *(200-100)*800 = 40000

E:  ½ *(300-250)*(1000-800) = 5000

F:  ½ *(250-200)*(1000-800) = 5000

Change in consumer surplus = -(B+E) =  – ( 40000-5000) = -45000

Change in producer surplus =B-F = 40000-5000 = 35000

Dead weight loss = -45000+35000 =-10000

Q3:Part2

The free price or domestic price is Pf found by the equilibrium of domestic supply and demand. If we allow imports then the price is lower at Pm. The imbalance between demand and supply at this price equals the quota level as shown in red, and it equals Q2-Q1.

This quota causes an effect on all the economic agents involved :

Buyers/Consumers pay lower price for beef now, allowing them a higher consumer surplus of area equal to A+B+D+E. Before trade this was only A, so that the increase equals B+D+E

Domestic sellers/producers will be worse off, as they are able to sell only Q1, instead of Q* earlier without trade. This is reflected in lower surplus for them, which falls to C only, as compared to B+C earlier. The decrease is  –B.

Overall change in welfare =  -B+(B+D+E)  = D+E. The Canadian society is better off with trade.  

There is an added complication now. The imports are higher than the extent to which the government wants them to be. This means the government imposes quotas which allow lesser imports as compared to a no quota regime.  We depict imports in red  and quota level in green in a new diagram below. We now compare the two cases which differ in the level of quota imposed. We refer to case a as free imports regime while the other is quota regime.  

• Price in quota regime is higher than under free imports regime. (Pq > Pm). This allows domestic producers to supply more Q* rather than Q1, raising their producer surplus rises from D to C+D. The gain = D.
• Consumers are unhappy since they face higher price of Pq rather than Pm. Consumer surplus was A+B+D+E+F+G +H. It is now reduced to A+B+G, so that loss = -D-E-F-H.
• The total effect on Canadian society is the sum of consumer and producer surplus and revenues( which are zero in this case). This total is represented by the area H+E+F+G in a free import regime, but now reduced to just G

Part 3

All information is shown in the figure above. We show the effects of tariff in the table below:

The calculations for the last coloum are shown below:

C = .5*(250-125) *1.6  +1.6 * 125  = 87.5 +200 =287.5

D = .5*(5.6-4)*(250-125) = 87.5

E= (500-250) *1.6 = 400

F= .5*( 5.6-4) *(625-500) = 87.5

References

Mankiw. N.G , Principles of Economics  2008 available from  https://homepage.ntu.edu.tw/~josephw/Principles_08F_lecture2a.pdf  [8 April 2017]

Study notes: Explaining Consumer surplus, available from:https://www.tutor2u.net/economics/reference/consumer-surplus [8 April 2017]     

Scarcity, Choices, and Opportunity Costs: Production Possibility Curve, available from
https://www.oswego.edu/~atri/e101ppc.html  [8 April 2017]

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