Production Possibility Frontier, Tax Incidence, Price Regulation, and Natural Disasters

Question 1: The Production Possibility Frontier
a) Production Possibility Frontier Graph
1 2 3 4 5 6
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
Production Possibility Frontier
Cars Bicycles PPF
Figure 1 Production Possibility Frontier for Bikes and cars
b) The ‘production possibility curve’ of a country refers to the curve that denotes the
maximum output a country can produce with all it’s given resources at a level of
technological progress. Resources in an economy are limited and a country must trade-off
between the goods and services it chooses to produce with the aim of profit maximization
in mind.(Rittenberg & Tregarthen, 2017)
The purpose of the production possibilities frontier (PPF) is two fold:
 It illustrates the trade offs that an economy has to make In its trade decisions.
 It has to show the gains from specialization and gains from trade.
Some of the assumptions of Production Possibility Frontier:

i) The economy is divided in two goods. All the total resources such as land, labour and capital
are involved in production of one or both of only two goods.
ii) The total level quantity of the resources does not change.
iii) Techniques of production and technology remain the same.(Mankiw, 2008)
iv)Resources are being used with maximum efficiency. (Rittenberg & Tregarthen, 2017)
c) Newland can adopt three strategies
i)It can import bicycles and card to meet demand.
ii) It can try to employ more efficient technology and processes to increase production to meet
demand.
iii) It can outsource production of bicycles and cars.

Question 2: Part I: Tax Incidence
Consumer surplus measures the benefit buyers receive from participating in a market.
Figure 2 Consumer Surplus
Source:(Mankiw, 2008)
Price is determined when demand equals supply. Hence,

Price (P) = Qd = Qs
I,e 20-P = P-1
I,e 3P= 21
I,e P= 7
Hpwever, this is the price without the tax.
Equilibrium quantity I,e Quanitity demand Qd
Quantity Demanded = 20-P
Quantity Demanded = 13
Quanity Supplied = P-1
Quanity Supplied = 6
Qd= 13
Incidence of Tax:
The increase in price will cause the demand to fall.
New Qd = 10
Incidence oif Taxation = 10 X $3
Incidence of Taxation = 30
The tax will be borne by the consumer.
Therefore , Deadweight Loss= Output Reduced X Tax
= 7 X3
Deadweight Loss = 21