Question

Suppose Nike opened a new production plant in China to produce sports clothes and shoes. After operating for several years, the company collected the following data about production possibilities (left table) and marginal benefit (middle table).

PPF		MC		MB
Shoes (million pairs per year)	Clothes (million pieces per hour)	Shoes (million pairs per hour)	Clothes (million pieces per hour)	Shoes (million pairs per hour)	Clothes (million pieces per hour)
0	35
1	32			0.5	10
2	27			1.5	8.5
3	20			2.5	7
4	11			3.5	5.5
5	0			4.5	4

1. Draw Nike’s production possibility frontier (PPF) and explain how your graph illustrates tradeoff/scarcity.
2. Suppose currently Nike produces 2 million pairs of shoes and 27 million pieces of clothes per year. If the company were to produce one additional million pairs of shoes a year, what would be the associated opportunity cost?
3. Please list Nike’s Marginal Cost data in the right table above (next to its production possibilities and marginal benefits data). Then pick a data point you just listed and explain its economic meaning.
4. A data point in the MB table is (0.5 million pairs of shoes per year, 10 million pieces of clothes per year). What is the economic meaning of this data point?
5. Based on these data, what would be Nike’s optimal shoe and cloth output? Explain the reasoning behind your answer.

Answer 1

Solution:

Given,

The following diagram is Nike’s production possibility frontier (PPF).

The graph illustrates tradeoff/scarcity as the production possibilities frontier is graphed as a curve on which, one of the commodities is shown on the x-axis, while the other is shown on the y-axis. The entirety of the curve is made up of points at which the two commodities are being produced in different amounts, most efficiently using the limited resources that they require.

The PPF of Nike shows that assuming ceteris paribus, if all the resources are employed in the production of clothes, then 35 million pieces of clothes can be produced in an hour while 0 units of shoes are produced. Simlarly, if all the resources are employed in the production of shoes, then 5 million pairs of shoes can be produced in an hour while 0 units of clothes are produced. A combination of shoes and clothes can only be produced if the resources are divided between these two commodities and some amount of both the commodities are given up to accomodate the other commodity, that is, the production of a commodity can only be increased if some amount of the other commodity is given up. For example, in the graph, the production of shoes can be increased from 3 million pairs per hour to 4 million pairs per hour only by reducing the production of clothes from 20 million pieces per hour to 11 million pieces per hour.

Suppose currently Nike produces 2 million pairs of shoes and 27 million pieces of clothes per year. If the company were to produce one additional million pairs of shoes a year, the associated opportunity cost would be (27-20)/(3-2) = 7 million pieces of clothes.

The marginal cost data in the table is as follows:

PPF	MC	MB
Shoes (million pairs per hour)	Clothes (million pieces per hour)	Shoes (million pairs per hour)	Clothes (million pieces per hour)	Shoes (million pairs per hour)	Clothes (million pieces per hour)
0	35
1	32	3 pieces cloth	0.33 pair of shoes	0.5	10
2	27	5 pieces cloth	0.2 pair of shoes	1.5	8.5
3	20	7 pieces cloth	0.14 pair of shoes	2.5	7
4	11	9 pieces cloth	0.11 pair of shoes	3.5	5.5
5	0	11 pieces cloth	0.09 pair of shoes	4.5	4

The marginal cost is the opportunity cost of consuming an extra unit of a good. Here let us take the production of shoes. The marginal cost of producing extra one million pairs of shoes can be calculated as:

Say Nike wants to increase the current production of shoes, 4 million pairs per hour, by another million pairs per hour. For this the some amount of resources need to be shifted from production of clothes to shoes, this will reduce the current production of clothes from 11 million pieces per hour to 0 units. Therefore, the marginal cost for one million pairs of shoes = (11-0)/(4-5) = -11 million pieces of clothes, which means that the production of clothes will fall by 11 million pieces per hour.

Marginal benefit is the benefit or happiness, obtained from consuming or producing an extra unit of a good. A data point in the MB table is (0.5 million pairs of shoes per year, 10 million pieces of clothes per year). The economic meaning of this data point is that as the production of shoes increases from 0 pairs per hour to 1 million pairs per hour, the benefit obtained by Nike from that increase of 1 million pairs of shoes per hour is 0.5.

Similarly, as the production of clothes fall from 35 to 32 million pieces per hour, the marginal benefit received by Nike is 10.

Based on these data, what would be Nike’s optimal shoe and cloth output is 3 million pairs of shoes and 20 million pieces of clothes per hour. This is because the optimal mix both the goods for Nike to produce occurs at point where the indifference curve is tangent to the production possibility curve. Since, the slope of the indifference curve equals the price of good X divided by the price of good Y, the slope of the production possibility curve, opportunity cost, at the equilibrium point where it equals the slope of the indifference curve must also equal the price of good X divided by the price of good Y.

So assuming the marginal benefit to be the price, at 3 million pairs of shoes and 20 million pieces of clothes per hour the slopes are almost equal.