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## The Production Possibility Frontier

1: The Production Possibility Frontier

Table 1 – Production Capacity of Newland

 Cars Bicycles 30,000 0 28,000 1,000 24,000 2,000 18,000 3,000 10,000 4,000 0 5,000

Use information in Table 1.1 above to answer the following questions:

a. Using the above figures, map out the Production Possibilities Frontier (PPF) for the production of the Cars and bicycles (Hint! Use Microsoft Excel, for accuracy)

b. In your own words, while making use of the graph that you have created in part a, explain what the PPF is. Cleary state all assumptions and properties of the PPF.

c. Newland usually has a demand of 3,000 bicycles and 18,000 cars. Suddenly Newland receives notice that the demand has increased to 4,000 bicycles and 20,000 cars. Discuss and explain at least three possibilities of how Newland could meet that demand. (Hint: State any appropriate assumptions made).

2: Part I: Tax Incidence

Suppose the demand for and supply of pizza functions are:

QD = 20 – 2P                        (1)

QS = P – 1                             (2)

Where, QD is the quantity demanded; QS is the quantity supplied and P is the price. Suppose the, government imposes \$3 tax per pizza purchased. Calculate the incidence of the tax and deadweight generated by the tax. Show all working steps and indicate your results on a correctly labelled demand and supply diagram.

Part II. Price Regulation

a. The US Farm Bill 2012 indicates that the domestic price of wheat is set at \$300 per tonne, which is above the market equilibrium level of \$250 per tonne, in order to support for domestic wheat growers. On a graph, show and explain the impact on the equilibrium quantity and price of wheat.

b. On a graph, explain the change the consumer surplus, producer surplus and the deadweight loss in the domestic wheat market. Assume that the US does not trade wheat internationally.

c. Calculate the changes in consumer surplus, producer surplus and deadweight loss. (Remember 1 kilo tonne = 1,000 tonnes)

d. Is the outcome of the US Farm Bill fair? Critically Your discussion should reflect the

fair rules and fair results notions of fairness.

3: The Impact of Natural Disaster

Bush fires and drought have destroyed coffee plantations in Brazil, the world’s leading producer of coffee. Manufacturers of coffee products are discussing ways of averting a projected shortfall in coffee in the next five years. Nestle, manufacturer of Nescafe and Nespresso, is teaming up with Brazil to trial plantations of new coffee specie that could mature in twelve months.

With the aid of the demand and supply diagram, answer the following questions:

a. Analyse the impact of the drought and bush fires on the supply of coffee.

b. Suppose worldwide demand for coffee products increases soon after the drought and bushfires. Analyse the effect on the world equilibrium quantity and price of coffee.

c. Analyse the effect on the world equilibrium price and quantity of coffee, if the trial of the new specie is successfully. Clearly state any assumptions you make.

The Production Possibility Frontier

1.a) Given the Newland’s production capacity, the PPF (Production Possibility Frontier) for production of bicycles and cars are highlighted in the below diagram;

Table 1: Production Possibility Frontier of cars and bicycles

Source: (Author’s Creation)

b. The PPF curve mainly signifies maximum possible output of the two commodities given the inputs such as resources. It generally assumes that all the inputs are effectively utilized in production (Baumol & Blinder, 2015). Few variables involving technology, laborers impact the resources and thereby it shows that point where PPF lies. The PPF curve indicates two commodities production possibilities given the fixed resources. Furthermore, this PPF curve helps to determine efficiency of producing two goods at same time.

This diagram highlights PPF for the production of bicycles and cars. The point A as well as point B on the curve signifies that resources are allocated efficiently by a particular economy. Point B indicates that if a country starts to manufacture large number of bicycles, then they should divert those resources which are used for producing cars. On the contrary, Point A highlights that if the nation starts to produce huge number of cars, then they should give up some resources for manufacturing bicycles. Moving from the point A to B, the economy will reduce total car production in comparison with rise in total bicycle output. The point Y depicts that the resources are utilized inefficiently, which indicates that the economy is not producing huge number of bicycle and cars even though resources are given (Hall & Lieberman,, 2012).

## Part I: Tax Incidence

The assumptions of the PPF are illustrated below:

• Technology that is to be utilized in production of goods is taken to be fixed
• It is assumed that resources are utilized efficiently
• The resources used for manufacturing commodities could be relocated in order to manufacture another commodity(Taussig, 2013).

Properties of the PPF are explained below:

• The PPF curve is basically negatively sloped since variation in amount of one commodity is indirectly related to variation in amount of another commodity
• The shape of PPF curve is mainly concave due to rise in marginal opportunity cost.

c. The three major possibilities by which the Newland could meet rise in demand are given below:

• This nation could increase supply of the two commodities in order to meet the customer’s requirement.
• Newland might bring in emerging technologies in order to meet increased demand of the commodities.
• Import of commodities will facilitate Newland to meet the demand for these two commodities, which in turn will increase its supply.

2. Part 1

The demand for and supply of pizza function are given as under-

QD= 20-2P

Qs= P-1

The equilibrium in the market occurs when the demand curve cuts the supply curve, ie QD=Qs

20-2P=P-1

20+1=P+2P

21=3P

P=21/3=7

At P=7, QD=20-2*7=20-14=6, Qs= 7-1=6. The diagram is shown below:

Figure 2: Market equilibrium before tax

Source: (as created by author)

Now if the government imposes \$3 tax per pizza that is purchased, then the demand function will be-

QD= 20-2(P+3)

Qs=P-1

The new market equilibrium is-

QD= Qs

20-2(P+3)=P-1

20-2P-6=P-1

3P=20-6+1

3P=15

P=5

At P=5, Qd= 20-2(5+3)=20-16=4, Qs=5-1=4

Figure 3: Market equilibrium after tax

Source: (Author’s creation)

## Part II: Price Regulation

Figure 4: Deadweight loss generated by tax

Source: (Author’s creation)

Tax incidence portrays distribution of tax obligations that should be covered by both seller as well as buyers (Sloman, Norris & Garrett, 2013). It reveals which buyers and producers will give price of new tax. After imposition of tax, the new equilibrium price is now \$7 per pizza. This means that sellers pass the burden to purchasers, who will have to pay \$1` more per pizza. Meanwhile, while sellers will attain \$2 less per pizza they sell.

Tax generates deadweight loss because it prevents the people from purchasing the product that cost high after imposition of tax than it would be before imposition of tax. Deadweight loss refers to loss of good economically which occurs owing to imposition of tax (Taylor et al., 2014). The deadweight loss generated by tax –

Part 2

a)

Figure 5: Impact of equilibrium quantity and price of wheat

Source: (Author’s creation)

## The Impact of Natural Disaster

The market equilibrium occurs when the demand and supply curve intersects each other (Reisman, 2013). From the above diagram , it can be seen that the equilibrium price is \$250 and equilibrium quantity is 1000. The US Farm Bill indicates that domestic price of wheat is set at \$300, which is above the equilibrium point. As market price is set above the equilibrium price , the total quantity supplied becomes greater than total quantity demanded. This, it leads to creation of surplus and hence equilibrium price of wheat will decline and equilibrium quantity will increase.

b) The figure below reflects consumer surplus, producer surplus and deadweight loss. The triangle abc is the consumer surplus and cbed is the producer surplus. The triangular section bfg is the deadweight loss.

Figure 6: Consumer surplus, producer surplus and Deadweight loss

Source: (Author’s creation)

c. Consumer surplus relates to welfare measurement in which each person needs to attain from consumption of commodity. It is calculated as –

CS= ½*(base*height)

 Consumer surplus Qd Change in price 800 Pmax 400 0 Pd 300 CS 40000

Producer surplus is that excess amount which the producers obtain from selling of products in market. It is estimated similar to that of consumer surplus.

 Producer Surplus Length Breadth Area of Rectangle 300 800 200 80000 Area of Triangle Height Base 200 800 100 0 40000

PS= 8000+4000=12000

DWL= ½*(P2-P1)*(Q1-Q2)

 Deadweight loss Change in price Change in Quantity P2 200 Q0 1000 P1 300 Q1 800 DWL -10000

d. The outcome of US farm Bill is not fair owing to occurrence of deadweight loss. As it can be seen from the above situation that surplus occurs in the market, this will create problem for the government as domestic consumption has not risen.

3.a) The coffee production needs a favorable climatic condition. Natural calamities often hamper coffee production and thus lead to deficiency in supply. This is shown in the figure given below:

Figure 7: Impact of bushfires and drought on supply of coffee

Source: (Author’s creation)

This figure shows that equilibrium occurs at point E where demand and supply of coffee shown by SS and DD curve intersects each other. Corresponding to this equilibrium point, the equilibrium price is P and quantity is Q.  As natural calamities hampers coffee yield, the supply curve shifts in leftward direction from SS to S1S1. Thus, new equilibrium price occurs at P1 and quantity is Q1.

b. Rise in coffee goods after this natural calamities upward pressure on its demand. Moreover, deficiency in supply of coffee due to these calamities impacts the global market. Rise in demand leads to rise in price as well as quantity in global market. Shortage of supply also increases price but reduces the quantity in the market (Mankiw, 2014). Hence, quantity is thereby ambiguous due to opposing forces. Depending on the situation, there might be three cases. In these three diagrams, DD and SS depicts global demand and supply respectively. The global price is P but the quantity differs based on different situation.

Case 1

Rise in global demand exceeds decline in supply leads to decrease in rise in price and quantity.

Figure 8: Rise in demand exceeds supply crisis

Source; (Author’s creation)

Case 2

Rise in demand is less than decrease in supply which results in decline in increase in rise in price but reduces quantity.

9: Reduction in supply exceeds rise in demand

Source: (Author’s creation)Figure

Case 3

The change in demand and supply is same. This leads to rise in price but quantity remains unchanged.

Figure 10: change in demand and supply is same

Source: (Author’s creation)

c. If trial of specie becomes successful, global supply of coffee tends to increase. The rise in supply also increases demand and hence this leads to rise in equilibrium quantity and price. The three cases are shown below:

Case 1

Figure 11: Supply is greater than  demand

Source: (Author’s creation)

Case 2

Demand force is greater than supply force, it leads to increase in price.

Figure 12: Demand is greater than supply force
Source; (Author’s creation)

Case 3

Demand and supply changes in equal magnitude, which in turn keeps price unchanged.

Figure 13: Demand and supply changes in equal force

Source; (Author’s creation)

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