REVIEW QUESTIONS
1. Consider a simple economy producing two goods: cars and milk. The following
table gives several points on this economy's production possibility frontier.
Cars
(1000's/year)
0
1
2
3
Milk (1000's of gallons/
year)
60
50
30
0
a. Graph this economy's production possibility frontier.
b. Why is the production possibility frontier downward sloping? Be sure to explain
economic intuition behind that fact.
The negative slope of the PPF illustrates the fact that larger quantities of cars
correspond to a smaller amount of milk, and vice versa. This happens because all the
economy's resources are already in use, and therefore obtaining more cars would
always require sacrificing some milk. In economic terms, the negative slope is due to
the presence of opportunity cost.
c. Why is the production possibility frontier concave? Be sure to explain economic
intuition behind that fact.
The slope of a particular segment of the PPF shows how much good on the vertical
axis (milk) has to be sacrificed in order to obtain an additional car (the good on the
horizontal axis). The steeper the slope the larger the aforementioned sacrifice has to
be. This happens as we move from left to right and therefore towards larger quantities
of cars, which represents the principle of increasing costs discussed in class - as we
produce more and more cars, each additional car costs us more in terms of milk we
have to forgo.
d. Suppose the economy is currently producing 2000 cars and 30,000 gallons of milk.
What is the opportunity cost of producing additional 20,000 gallons of milk?
We can see from either the table or the graph that if 30,000+20,000=50,000 gallons
of milk were produced, the economy could at the same time produce no more than
1000 cars. This represents a decrease by 1000 cars relative to the current production.
(2000 - 1000 = 1000). The opportunity cost of additional 20,000 gallons of milk is
1,000 cars.
e. The synthetic production of Bovine Growth Hormone (BGH) allows dairy farmers
to get twice as much milk from each cow. In terms of this production possibility
frontier, this means that this economy can now produce twice as much milk at each
level of car output. With the economy currently producing 2000 cars, Jerry claims that
the development of BGH allows the economy to produce more milk and more cars.
Do you agree? Explain carefully, using an appropriate diagram to illustrate your
answer.
Yes, Jerry is right. As a result of the BGH introduction, each point on the PPF will be
located twice as high as it was originally. See graph. It is easy to see that, being at
point A (corresponding to 2000 cars and 30,000 gallons of milk), the economy can
move up to point B (more milk), to the right to point C (more cars), or have more milk
and more cars at the same time (point D).
2. A team consisting of three people is working on a big project, which involves
manual entry of data in a computer, with subsequent processing of these data and
making a poster presentation.
Naturally, each member of the team has different abilities in performing either task.
Adam can make 1 poster or 400 data entries in a day. Hard-working Becci can make 2
posters or 1200 data entries in a day. Artistic Cliff can make 3 posters or 900 entries
in a day.
a. Originally, the entire team (each of them having their own personal computer) starts
with entering data. How many entries will be made in a day?
400 + 1200 + 900 = 2500
b. As the time comes to start making posters, you decide to assign one member of the
team to this task. Whom would you choose? Explain why.
Since along with making posters you will still need to enter data, you may want to
look for the scenario in which each poster produced costs you the least in terms of
data entries forgone. If you ask Adam to make posters, the opportunity cost of each
poster is 400 entries. In the case of Becci, each poster costs 1200:2 = 600 entries. If
Cliff switches to making posters, then each poster costs your team 900:3 = 300
entries. The last option is the most attractive, so Cliff should be the first who is
assigned to do the posters.
c. As you make this decision, what is the opportunity cost of each poster made?
The answer is given above: Each poster costs 300 data entries.
d. As there is less and less data remaining to be entered, another person can shift to
making posters as well. Which of the remaining two members of the team will you
choose this time? Explain your choice. As a result, what is the opportunity cost of
each additional poster you will get?
Our calculations in part b indicate that Adam should be next, since between him and
Becci he has the lowest opportunity cost of each poster - 400 data entries.
e. Draw a sketch of your team's production possibility frontier, placing the number of
numerical entries on the vertical axis and the number of posters on the horizontal axis.
f. What does the order in which you reassign your team members from data entry to
making posters imply about the shape of your PPF? Which important economic
principle does this fact illustrate?
The PPF came out concave. This happened because, as successive team members are
assigned to making posters, the opportunity cost of each additional poster increases.
This is an illustration of the principle of increasing costs discussed in class.