Exercise Set 2
OPPORTUNITY COST

I. Objectives

• To sketch the production possibilities frontier (PPF)
• To illustrate the notion of efficient utilization of resources
• To understand the interpretation of the slope at a point on the PPF
• To compare the slopes at different points on the PPF
• To understand the Principle of Increasing Costs

II. Data

• The equation of the PPF is given by 2X² + Y² = 10000, where X is the quantity of Good 1 (muffins) and Y is the quantity of Good 2 (computers).
• Sketch the PPF with muffins on the horizontal axis. Indicate the intercepts. Note that the PPF is bowed outwards.
• Select a value for X. Click on Gimme PPF! to obtain the maximum amount of computers (Y) that can be produced, and the slope of the PPF at that point. (For those who remember their calculus days, the slope is -2X/Y.)
  
  

  Muffins: X =

  Computers: Y =

  Slope =

III. Questions

1. Sketch the PPF with muffins on the horizontal axis.
   1. Compute the horizontal and vertical intercepts.
   2. Indicate them on the graph.
2. Suppose the country produces the following combination: 65 muffins and 30 computers.
   1. Is production efficient? Explain.
   2. Indicate the production point on the graph.
3. Given its resources, can the country produce 60 muffins and 56 computers? Explain, using the graph.
4. Suppose the country is currently producing on the PPF at Point A where X = 45. The slope at A is given to be -1.17.
   1. Obtain the corresponding quantity of computers produced.
   2. Indicate Point A on the graph.
   3. If the country were to produce an additional muffin at A, it must give up __________ computers. Explain.
5. Consider Point B on the PPF such that X = 60. The slope at B is -2.27.
   1. Find Y and indicate Point B on the graph.
   2. The opportunity cost of an additional muffin at B is ____________ computers.
6. Compare Points A and B.
   1. The opportunity cost of producing muffins at B is [ greater / smaller ] than that at A.
   2. The magnitude of the slope at B is [ greater / smaller ] than that at A.
   3. Do the slopes at A and B reflect the principle of increasing costs?
7. In which case will the future PPF lie further to the right:
   (a) The country's current production occurs at Point A, or
   (b) The country's current production occurs at Point B?
   
   Explain. Provide sketches of the likely positions of the future PPF in both cases. [Hint: Which of the two goods is considered to be a capital good?]
8. Evaluate the following statement critically: "If the country devotes more resources to the production of consumption goods than that of capital goods, the resulting production is not efficient."

IV. Additional questions

1. A country produces two goods using various inputs. Which of the following will cause the PPF to shift outwards?
   1. An increase in the labor force
   2. Improvement in technology
   3. Fall in unemployment
   4. All of the above
   5. Both a and b

2. The principle of increasing cost
   1. Implies that an increase in wages will lead to a higher cost of production for firms
   2. Is exhibited by the bowed-out shape of the typical PPF
   3. Implies that production will never occur at some point above the PPF
   4. All of the above
   5. None of the above

3. Efficient allocation of resources occurs when
   1. Production occurs at a point on the PPF
   2. The quantity of capital goods produced is greater than that of consumption goods
   3. All resources are used fully
   4. Both a and b
   5. Both a and c

4. The unemployment rate fell from 8% to 6%. This means that
   1. The economy moved closer to the PPF
   2. The PPF shifted outwards, away from the origin
   3. The PPF shifted to the left towards the origin
   4. The economy moved down along the PPF
   5. None of the above

   Consider a typical PPF with quantity of beer on the X-axis and quantity of milk on the Y-axis. Now answer Q.5 and Q.6 below.

5. The magnitude of the slope of the PPF at a point represents
   1. The opportunity cost of producing an additional unit of beer
   2. The opportunity cost of producing an additional unit of milk
   3. The amount of beer that must be foregone in order to produce an additional unit of milk
   4. Both a and c
   5. Both b and c

6. As the economy moves down along the PPF, the opportunity cost of producing beer
   1. Increases
   2. Decreases
   3. Will decrease if unemployment is not too high
   4. Remains constant
   5. Initially increases and then decreases

7. The principle of increasing costs is associated with which of the following?
   1. The PPF becomes increasingly steep as the economy moves up and along the curve to the left
   2. Inputs tend to be specialized in production
   3. A new invention causes the economy to move closer to the PPF
   4. All of the above
   5. Both a and c

8. A country produces two goods. Which ONE of the following will not cause the PPF to shift outwards?
   1. A more highly-educated labor force
   2. Improvement in technology
   3. Fall in unemployment
   4. A discovery of mineral resources in the country
   5. Addition to the country's capital stock

9. An increase in the unemployment rate would imply that
   1. The economy has moved to a point closer to the PPF
   2. The economy has moved away from the PPF to a point closer to the origin
   3. The PPF has shifted to the left towards the origin
   4. The economy has moved down along the PPF
   5. None of the above is correct

10. Ray, the well-known economist, has developed a model of the economy of his home country, Ovac. The other day, he used it to analyze the effect of a sales tax on the consumption of batteries. What he discovered electrified him. He wrote: Imposing a tax of 75 cents-a-battery will lead consumers to buy 100,000 fewer batteries a year.
    1. Ray's statement is an example of normative economics. True or false? Give reasons. If false, how would you correct it?

11. One day, Ray started thinking about his country's PPF. Ovac was currently producing two goods - machines and nachos. He knew that production was efficient. This year, Ovac's output was going to be 550 machines and 3000 tons of nachos. He wondered what next year's PPF would look like. Then he turned to his trusted model. What would next year's PPF look like, he wondered, if Ovac produced at another point on the PPF this year, say 700 machines and 2100 tons of nachos?
    1. Explain what a PPF represents.
    2. Sketch Ovac's PPF for the current year. Indicate this year's production point on the graph.
    3. Does the production point lie below the PPF? Why?
    4. Sketch possible positions of the PPF for next year under the two scenarios mentioned above. Explain why this year's choice of production affects next year's production possibilities.
    5. Say, Ovac's economy did increase its production of machines from 550 to 700. What would be the opportunity cost of doing so? Explain.

	1e 2b 3e 4a 5a	6a 7b 8c 9b