Objectives This assessment item relates to the course learning outcomes 1, 2, 3 and 4. Question 1 (22 marks) Consider the following production possibilities frontier data in the table below. ( 5...

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Question 1 (22 marks)
(a) Consider the following production possibilities frontier data in the table below. (5 marks)
A B C D E F
Capital goods 30 28 24 18 10 0
Consumer goods 0 2 4 6 8 10
(i) Draw a diagram with appropriate labels.
Answer:
(ii) Indicate attainable, unattainable, efficient and inefficient areas on the diagram.
Answer:
All points under and along the PPF is attainable.
Area outside the PPF is unattainable
All points on the PPF are efficient
And area under and outside the PPF is inefficient
Refer the figure below
30, 0
28, 2
24, 4
18, 6
10, 8
0, 10
0
2
4
6
8
10
12
0 5 10 15 20 25 30 35
C
o
n
su
m
e

go
o
d
s
Capital goods
PPF
PPF

(iii) Explain the concept of increasing opportunity costs using data provided.
Answer:
Opportunity cost here is defined as the number of consumer goods that needs to be forgone to produce
one more unit of capital goods and at any production point, it is given as the ratio of change in
consumer goods to change in capital goods.
Using this formula, we can summarize the opportunity cost of production at different production point
on PPF:

Opportunity
cost
A
B 1
C 0.5
D 0.33
E 0.25
F 0.2
We note that as we increase the production of capital goods (i.e. as we move from point F to A), there
is rise in the opportunity cost of production, implying law of increasing opportunity cost of
production. Because of this, we have a concave PPF.
(iv) Using the data provided draw a new diagram showing growth in the resource base. Explain the
changes to the production of both goods.
Answer:
When there is growth in the resource base, we would be able to produce more of both the goods –
consumer and capital goods. So in this case, the PPF curve would shift rightward as shown in figure
elow:
(v) Assume that the decision is made to invest more in capital goods than in consumption goods.
Using the data provided draw a diagram and explain the impact of this decision on future
production capacity.
Answer:
When decision is made to invest more in capital goods than in consumption goods, economy’s ability
to produce capital goods will rise more than its ability to produce consumer goods. So although the
production possibility frontier in this case would shift outward but the shift would be more outward in
case of capital goods, implying economy’s ability to produce capital goods has increased more than its
ability to produce consumer goods. [Refer the figure below]
(b) Suppose demand (QD ) and supply (QS) in a market can be expressed by these equations:
(5 marks)
QD= 170-1.5*P
QS= 50+2.5*P
(i) Complete the table. What is the equili
ium price and quantity? If the prevailing market
price is $60, what are the quantity demanded and the quantity supplied?
Answer:
P QD QS
$10 155 75
$20 140 100
$30 125 125
$40 110 150
$50 95 175
$60 80 200

We note that Quantity demand equals quantity supplied when price is $30. So equili
ium price is $30
and the co
esponding quantity i.e. 125 is equili
ium quantity.
At price = $60, quantity demanded = 80 while quantity supplied = 200
(ii) Draw the diagram and calculate the change in the equili
ium if demand changes to
QD= 200-0.5*P. Explain why the change could occur (with examples).
Answer:
P QD QS
New Demand: Qd' =...