Question

1. Suppose Urbanville initially has fully employed resources and now experiences a recession which causes an increase in unemployed resources (most likely labor). Show with the PPF model (graph) what occurs when there is an increase in unemployed resources by drawing a graph of the above economy (don’t worry about the numbers, just a qualitative answer will suffice; put good Z on the horizontal axis when you draw the graph)
2. Scientists in Urbanville have created a new technique that allows them to build more of good X than before with the same resources (an increase in technology in good X production only). Show the effect of this increase in technology in good X on the PPF (however, put good Z on the horizontal axis when you draw the graph). This is only a qualitative answer, you don't have to put numbers on the axis.
3. Show, using a supply & demand graph, the effect on the equilibrium price and quantity of the good in question of the following events. Assume markets are initially in equilibrium. These are qualitative answers. An original and new market equilibrium on the graph is needed. Show that clearly. The market for Peanut Butter: The price of jam & jellies (a complement to peanut butter) declines.

Answer 1

Production possibility frontier is a locus of all the point which shows different combinations of two goods that an economy can produce with full utilisation of given resources.

A economy will produce on PPFonly if it is utilising its resources fully and PPF will shift only if the amount of resource increase or decrease or there is a change in technology.

In the graph below, Good X is on y axis and good Z is on X axis. PP' is the PPF. Initially Urbanville has fully employed resources so it is producing on the PPF at the point A.

Now it experiences a recession which causes an increase in unemployed resources which cause production of both goods to decrease but no effect on PPF because here the amount of resource does not change only its utilisation change so due to recession PPF remain same but economy will producer inside the PPF at some point U.

Now Scientists in Urbanville have created a new technique that allows them to build more of good X than before with the same resources (an increase in technology in good X production only). This implies that now the maximum production of good X increases which cause intercept of PPF on axis of good X to move upward while intercept on good Z axis to be remain same. Initial PPF is PP' and after technological change new PPF is P*P'.

The market for Peanut Butter initially in equilibrium at point E where equilibrium price is P* and quantity is Q*. As the price of jam & jellies (a complement to peanut butter) declines it will cause people to use more of peanut butter so demand for it increases which cause rightward shift of demand curve to D*D'' (in yellow) which cause rise in equilibrium price to P** and new increased equilibrium quantity Q**.