Diagram 1: The production schedule of firm ‘W’
From the diagram above and the information given, we can infer that the opportunity cost of producing 20 cakes is going to be small, though it will vary for the different segments of the production schedule. If 500 cakes are produced the firms entire resources are allocated to the production of cakes, a fact evident in that no tractors are produced. If the number of cakes falls by 100, the remaining resources that are allocated to the production of tractors can make 10 tractors. So, for this range it can be inferred that every reduction by 10 cakes is able to release resources able to produce 1 tractor. So the opportunity cost of producing 20 cakes is a reduction of total production by the amount of 2 tractors. However, evidently the production schedule is non monotonic in nature and thus the opportunity costs of cakes will vary in each of the separate segments. For the next segment, an aggregative reduction of 150 cakes is required to increase the number of tractors produced by 10. So for this segment a reduction of production by the amount of 15 cakes is required to release enough resources to produce 1 additional tractor. Thus the opportunity cost of producing 20 cakes is less than 2 tractors in this segment. In the lowest segment, we find that a reduction by 240 cakes is able to produce 20 additional tractors. Thus for every 12 cakes not produced, one tractor can be produced. So in this segment also the opportunity cost of producing 20 cakes will be less than 2 tractors.
Evidently, the combination of 300 cakes and 30 tractors is not feasible. It lies beyond the production possibility frontier. The combination has been marked in red in the diagram. Since only 250 cakes can be produced if the number of tractors is 20, and in the number of either is increased the number of the other has to necessarily fall given the present technological constraint, 300 cakes and 30 tractors is a combination that is not plausible.
To obtain an outward shift in the production possibility frontier, the firm has to improve its technology so that more of both goods can be produced with a given amount of resources.
The PPF will shift inward if the firm for some reason faces a fall in productivity of the resources.
2. Assuming price of chocolate to be represented by ‘P’, the given equations can be rewritten as
P = 20-x and P = 4x. Now in equilibrium, P = 20-x = 4x => 5x = 20 => x = 4 which is the equilibrium quantity and putting x = 4 we get from the demand function p = 16 which represents the equilibrium price.
Diagram 2: The market equilibrium
In the diagram above, the equilibrium is shown graphically. Observe the demand curve satisfies the equation P = 20 – x as it originates from P = 20, x = 0 and falls downward thereon with a negative slope of unity. The supply curve satisfies P = 4x with P = 8 for x = 2, P = 16 for x = 4, etc.
The two curves intersect at P = 16 and x = 4 identifying these as the equilibrium price and quantities.
a) There is a new governmental law restricting the number of firms in the market so that many of them have lost their license
This will cause a reduction in the market supply of the product. So, the market supply curve will shift leftward as for each price the total output supplied in the market will be lower than earlier.
Diagram 3: Impact of the license
As shown in the diagram, such a leftward shift in the market supply curve, ceteris paribus, will lead to a higher equilibrium price and a lower equilibrium output. This is in essence a result of the increased market power of the remaining sellers as a number of their rivals are not able to compete anymore.
b) There is rapid increase in the price of oil
Though there will be no significant effect of a rapid rise of oil price on the market supply, the market demand will be influenced through the negative income effect of the oil price hike. Given that oil is a necessity and thus has an inelastic demand, a rise in its price therefore will imply a reduced income for the consumer that can be now allocated to the consumption of products such as chocolate ice cream. Thus, for each price the market demand will be lower. Thus there will be an inward shift of the demand curve.
Diagram 4: The effect of a sudden oil price hike
Evidently, as shown in the diagram, due to the shift in demand equilibrium price and quantity both will be lowered in this case.
c) People become more concerned about healthy eating:
Such concern will be likely to cause people to reduce their consumption of chocolate ice cream. So, as a result at each price the quantity of chocolate demanded will fall. Thus the demand curve will shift inward in this case as well. The effect will be the same as the previous case.
d) The price of the cacao ice-cream (very similar but not the same as chocolate ice-cream) goes down quite a lot.
This is essentially the case of a significant price reduction of a substitute good. If the substitution effect dominates the income effect so that a large number of people switch to the consumption of the substitute, the demand for chocolate ice cream will fall for each price thereby leading to an inward shift in demand. The effect will be similar to the previous two cases and the diagram will be the same in effect.
e) The labour unions push up a new law about an increase in the minimum wage
In this case, the cost of producing chocolate ice cream per unit rises. Thus to cover the additional costs and retain similar profits, firms will charge higher prices per unit. As a result the supply curve will shift upwards in similar fashion to the first case. The effect will be the same as in that case. The equilibrium price will rise and the equilibrium output will fall.
f) There is a technological breakthrough in the production of chocolate ice-cream
In this case, the productivity of the each chocolate ice-cream company that adopts this new technology will be able to produce a greater amount at the same cost per unit of output. Consequently, for each price a greater amount will be supplied in the market. Thus the supply curve shall shift to the right and as a result, the equilibrium price shall be lowered while the equilibrium output shall rise.
Diagram 5: The effect of a technological progress
g) The price of the complementing biscuits go up drastically
This is the case of the price of a complement rising significantly. Since the price of the complementary biscuits has risen, the price for consuming ice-cream and biscuits together has risen as well. So for each price, the demand for chocolate ice-cream shall fall causing an inward shift in the demand schedule and the effect shall be analogous to the previous cases where demand has fallen.
4) Given the demand curve, D= 80-2P + 5I if the value of I rises, the demand for hair cuts will be positively influenced since there is a positive relation between D and I. Therefore haircuts are normal goods.
For I = 3, D = 95 – 2P. In equilibrium, D = S => 6P = 95 => equilibrium price = 95/6 = 15.8333 => equilibrium quantity = 4 x 15.8333 = 63.3333
Now, if I falls to 2 then D = 90 – 2P. Equating this with the supply, we get 6P = 90 => P = 15 and putting this in either the supply or the demand function yields the equilibrium supply to be 60.
As exhibited in diagram 6, if the supply is perfectly inelastic, then a price ceiling will have no effect on the quantity supplied. If any amount is supplied to the market inelastically, implying that the supply is unresponsive to price changes, then understandably, the price ceiling will fail to have any additional impact on the amount supplied since it is predetermined. In this case the price ceiling will have the sole effect of dampening the profits of the producers.
Diagram 6: an inelastic supply curve, the case when a price ceiling fails to influence the market supply