Question

.     Explain the following:

      a)   Using a production possibilities schedule and assuming consumer goods and capital goods, explain how your positions on the curve can determine your location of the economic growth in the future. Use diagrams.

      b)   Why do we have increasing opportunity cost in real world and what does it mean in terms of the shape of the production possibilities curve? Carefully explain.

      c)   How does a production possibilities schedule show scarcity choice and opportunity cost? Using a diagram, carefully explain.

2.   Explain the following:

      a)   Using diagrams and supply and demand concept, carefully explain the impact of each of the following on equilibrium price and quantity of certain products.

            i)    Simultaneous decrease in price of raw material and decrease in income for a normal good (other things being equal).

            ii)  Simultaneous increase in business taxes and an increase in consumer income for a normal good (other things being equal).

      b)   Graphically explain price floor and price ceiling. Do these meddle with rationing function of prices? Carefully explain.

Answer 1

1. a. Let us suppose that a country makes only capital goods and consumer goods. Now, let us suppose that our country is on point A as shown in the image. Clearly, at this point, the country can produce more capital goods and lesser consumer goods. This implies that the country will have a greater capital goods stock and it can produce more of consumer goods using those capital goods. This implies that the country will experience higher future growth rate.

On the other hand, let us suppose that country is on point B with more consumer goods and lesser capital goods. Now, the consumer goods will get consumed in the present period only and lesser capital stock will be available in the future. Due to lesser capital stock, the capacity to manufacture more consumer goods will also decline. This implies that the country's future economic growth will slow down.

b. Increasing opportunity cost implies that as we keep on producing more and more of one good, we will require to use more and more resources for that. Due to this, we will have to produce lesser and lesser of the other goods. This happens because resources have specific use value.

For example, if a country is producing only wheat and rice, the resources which are efficient in producing rice might not be efficient in producing wheat. Due to this, producing more and more of one commodity will lead to us using way more of the other resource. This leads to higher opportunity costs as we keep on producing more of the good because resources are use specific.

In terms of shape of production possibility curve, the PPF will be concave in shape when the opportunity costs are increasing.

c. The production possibility curve shows opportunity cost and scarcity choices.

PPF is a locus of points showing the maximum we can produce if we employ our resources fully. It divides the region between feasible and unfeasible regions. This shows that there is a limit to what one can produce and one cannot go on infinitely producing all the goods. Because more of one good means lesser of other good. This is evident from the shape of the PPF. This shows us the presence of scarcity.

Now, the points of PPF tells us that how much of one good needs to be given up in order to produce more of the other good. This is the concept of opportunity cost. It is clearly reflected by every point on the PPF.