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Econ 102 Discussion Section 2 (Chapter 1, 2.1, 2.3, 3.1-3.3)
January 29, 2015
Scarcity, Opportunity Costs and Production Possibility Frontiers
Scarcity is the result of unlimited wants by economic actors, but limited resources to fulfill those wants. As a
result, economic actors face trade-offs in their decision-making. In considering the production decisions
facing firms, a useful tool for illustrating these trade-offs is the production possibilities frontier (PPF), a
curve showing the maximum attainable combinations of two products with available resources and current
technology. Assuming that the PPF is linear, given two possible combinations of goods possible using all
available resources we can find the equation of the PPF
Points lying on or beneath the PPF are considered attainable, while those above the line are unattainable.
Further, points on the PPF are considered efficient, while those below are considered inefficient. The slope of
the PPF represents the opportunity cost of producing the good on the x-axis in terms of the good on the yaxis; that is, it represents how much of the y-axis good you must give up to produce one more unit of the xaxis good.
In many introductory courses, we present the PPF as a linear graph, meaning that the opportunity cost of
producing each good remained the same regardless of how much was already being produced. In general,
firms actually face increasing marginal opportunity costs; that is, the opportunity cost of producing a good
increases as you produce more of it. This gives the PPF a concave shape.
We also often assume that the resources in the economy are fixed. Over time though, the resources available
to an economy may increase. Further, technological advances may increase the productivity of workers given
the same number of resources. These outcomes are associated with economic growth, and are represented by
outward shifts of the PPF
Markets and the Circular Flow Diagram
A market is a group of buyers and sellers
of a good or service and the institution or
arrangement by which they come together
and trade. Product markets are markets for
goods, while factor markets are markets
for the factors of production, which are
inputs used in the production of goods and
services. Two key groups participate in
markets: households, which both supply
the factors of production in factor markets
(earning income in the process) and
purchase goods in product markets (acting
as demanders in this case), which purchase
factors of production in factor markets and
supply goods and services in product
markets. The circular flow diagram above
illustrates this relationship.
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Econ 102 Discussion Section 2 (Chapter 1, 2.1, 2.3, 3.1-3.3)
January 29, 2015
Supply and Demand: An overview
The demand curve is a downward sloping line relating the quantity of a good demanded to the price of that
good. The demand curve is downward sloping due to the law of demand, which argues that all else equal, an
increase in the price of a good both reduces the purchasing power of the consumer (income effect) and
increases the relative price of that good compared to other goods (substitution effect), reducing the quantity
demanded of that good.
Factors that can shift demand include: income, prices of related good, tastes, population/demographics, and
expected future prices
Two goods are considered substitutes if an increase in the price of one good leads to an increase in demand
of the other; they are considered complements if an increase in the price of one leads to a decrease in the
demand of the other
The supply curve is an upward sloping line which relates the quantity of a good supplied to the price of that
good. It is upward sloping due to the law of supply, which argues that all else equal, an increase in the price
will increase the quantity supplied.
Factors that can shift the supply curve: price of inputs, technological change, prices of substitutes in
production, number of firms in the market, expected future prices
Notice that both for the supply and demand curve price is not listed as a factor that can shift supply/demand. When the price in a market (the variable on the y-axis) changes, this leads to a change in the quantity
supplied/demanded or a movement along the supply/demand curve in that market (the curves do not shift in
this case) A shift in the demand (supply) curve occurs when the quantity demanded/supplied changes at every
price in the market (the curves shift left/right in this case). Also referred to as an increase (decrease) in
demand (supply).
The equilibrium in a given market is found when the quantity supplied equals the quantity demanded.
Graphically this is illustrated by the supply curve intersecting with the demand curve. Whenever the market
is not in equilibrium (in micro these situations were referred to as either shortages or surpluses), market
forces will push the price towards equilibrium (e.g. in a market with a surplus, firms will lower the price of
their goods in order to sell their excess inventory).
Practice Problems
1. Productive efficiency means that
a) a good or service is produced at the lowest possible cost.
b) every good or service is distributed fairly.
c) every good or service is produced up to the point where marginal benefit is equal to marginal cost.
2. Allocative efficiency means that
a) a good or service is produced at the lowest possible cost.
b) every good or service is distributed fairly.
c) every good or service is produced up to the point where marginal benefit is equal to marginal cost.
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Econ 102 Discussion Section 2 (Chapter 1, 2.1, 2.3, 3.1-3.3)
January 29, 2015
Use the diagram to answer the next six (6)
questions
3. This PPF exhibits __________ marginal
opportunity costs.
a) diminishing
b) increasing
c) constant
4. Which of the points above are unattainable?
a) A
b) B
c) X
d) Z
5. Which of the above points are inefficient?
a) A
b) B
c) X
d) Z
6. Which of the above points are efficient?
a) A
b) B
c) X
d) Z
e) A and B
7. Suppose an increase in productivity allows workers to increase their production of laptops. What would
this mean for the graph above?
a) Shift of the x-intercept; no shift of the y-intercept
b) No shift of the x-intercept; shift of the y-intercept
c) Shift of the x-intercept; Shift of the y-intercept
d) No shift of the x-intercept; no shift of the y-intercept
8. If computers are considered as “capital good” while textbooks are considered as “consumption goods,
which point is the country’s growth rate likely to be the highest?
a) A
b) B
9. Which of the following is NOT true of households in the circular flow diargram?
a) They receive income in exchange for providing the factors of production
b) They purchase capital goods for use in production
c) They purchase goods and services from the product market
d) All of the above are true
10. Suppose the price of cheese curds rise from $1 to $2. What would we expect to occur in the market for
cheese curds?
a) Quantity demanded rises
b) Quantity demanded falls
c) Increase in demand
d) Decrease in demand
11. Suppose the cost of grapes increase. What would we expect to occur in the market for wine?
a) Quantity supplied rises
b) Quantity supplied falls
c) Increase in supply
d) Decrease in supply
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Econ 102 Discussion Section 2 (Chapter 1, 2.1, 2.3, 3.1-3.3)
January 29, 2015
12. Suppose that consumer interest in the Playstation 3 increases. At the same time, the price of the plastic
used to make the Playstation 3 falls. How would this affect the price of the Playstation 3?
a) Price would increase
b) Price would decrease
c) No change in price
d) Indeterminate
13. In the previous example, how would that scenario affect the equilibrium quantity in the market for the
Playstation 3?
a) Quantity would increase
b) Quantity would decrease
c) Quantity would remain the same
d) Indeterminate
14. Suppose that Coke and Pepsi are substitutes. If the price of Coke rises, what would happen to the demand
curve for Pepsi?
a) Shifts left
b) Shifts right
c) Moves along the demand curve to the left
d) Moves along the demand curve to the right
15. Apart from Coke, Coca-Cola also produces Fresca. Suppose price of Fresca rises, what would happen to
the supply curve of Coke?
a) Shifts left (Supply of Coke decreases)
b) Shifts right (Supply of Coke increases)
c) Stays the Same
d) Moves along the supply curve to the left
16. (The hardest question of the day, if you can do this, you’ve aced Chapter 3!) The market for corn in
country A is highly competitive. At the current market price of $5/bushel, there is a shortage of 100,000
bushels of corn in this country. Media reports claim that the price of corn will rise drastically in the near
future. According to these reports, the neighboring bounty B had witnessed a similar situation recently. At
the same price of $5/bushel, the shortage in country B was also 100,000 bushels and eventually the
equilibrium price in country B went up to exactly $10/bushel. Both countries are known to have equal
number of corn producers and the market supply of corn is identical at all prices. This, combined with the
fact that consumers in the two countries also have similar tastes and preferences, the new equilibrium price in
country A turns out to be below $10/bushel. Which of the following inferences can be drawn? (Hint: We
have said everything about identical supply curves in country A and country B. But we have not all things
about consumers. Try drawing some graphs here!)
a) The supply curve of corn must have shifted to the right.
b) The average income level of people in country A must be lower than country B.
c) The per capita consumption of corn in country A must be lower than country B.
d) The quantity demanded at the new equilibrium in country A must be higher than the equilibrium
quantity demanded at $10/bushel in country B.
e) The demand curve for corn must be flatter in country A than in country B.
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Econ 102 Discussion Section 2 (Chapter 1, 2.1, 2.3, 3.1-3.3)
January 29, 2015
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