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NCSU EC 205 - PRODUCTION POSSIBILITIES AND OPPORTUNITY COST

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PRODUCTION POSSIBILITIES AND OPPORTUNITY COSTProblems and Applications1. The United States is a rich and powerful nation with a skilled, productive labor force and a great deal of capital. Some less developed nations have few skilled workers and little capital. Why is scarcityan economic problem in rich and poor nations alike?Answer: Scarcity prevails in rich and poor nations alike because, no matter what the quantity or quality of economic resources in a nation, the more resources devoted to one use, the less available for other uses. The imbalance between resources and desires for their use remains, no matter how wealthy a nation might be.2. Make a list of the economic resources required to operate a restaurant. How is the number of meals perday that can be served limited by available economic resources and current technology for meal preparation and service?Answer: Tables, kitchen facilities, ovens, land and a building, cooks, waiters, and other labor are necessary to operate a restaurant. The entrepreneur is the person who conceives of the idea of the restaurant and opens it. The number of meals that can be served per day varies with such economic resources as the number of tables and number of waiters and cooks. The technology influences the speed at which meals of given quality can be cooked and served.3. The small nation whose annual production possibilities for food and clothing are illustrated in the tableand graph in Box 1 receives a gift of new machines for use in clothing production and agriculture. The new machines allow the nation to produce twice as much food and clothing, with the same number of workers and natural resources. Draw the new production possibilities curve for the nation, and show how the gift of capital expands its production possibilities.Answer:The gift of new machines will shift the production possibilities curve outward, and the intercept on both axes will be twice as far out from the origin as previously.4. Referring again to Box 1, suppose the nation receives a gift of new agricultural machinery that doublesthe maximum quantity of food that can be produced for any given quantity of clothing produced. Describe the new production possibilities curve, and explain why the gift expands the production possibilities of the nation to allow it to consume more food and clothing. Also describe the new combinations of food and clothing made possible by the gift.Answer: The new production possibilities curve will look similar to the one drawn in Box 6. The intercept on the food axis will be twice as far out as before the gift, but there will be no change for the intercept on the clothing axis.5. A civil war erupts in the small nation whose production possibilities curve is shown in Box 1. The war results in the destruction of capital and natural resources, and causes casualties that reduce the supply of labor available for production of food and clothing. Show the impact of the war on the nation's production possibilities curve for food and clothing.Answer:A war that destroys economic resources will cause a nation's production possibilities curve to shift inward.6. Suppose the production possibilities curve for the production of trucks and cars in a two-product factory has a constant slope equal to –2 when weekly car production is plotted on the vertical axis and weekly truck production is plotted on the horizontal axis. Describe the production possibilities curve, and explain why the law of increasing costs doesn't hold for the production of cars and trucks in the factory.Answer: If the production possibilities curve has constant slope, the law of increasing costs doesn't hold, because the opportunity cost of each extra unit of any one good will always be the same. If this were the case, it would imply that economic resources used to produce cars and trucks aren't specialized in the production of either of these goods. In other words, labor, capital, and other resources used in the factory are equally suited to produce either cars or trucks.7. Suppose you own and run a small business. You spend 40 hours per week managing the operation. By managing the business, you forgo your next best alternative, which is working at a job for someone else that pays $10 per hour. An accountant calculates all the money costs and revenues from the business, and tells you you're making a $300 profit per week. However, the accountant doesn't include the opportunity cost of your time as part of the money costs, because you don't incur any cash outlay topay for your time. Does it make sense for you to continue in business? Explain your answer.Answer: By working a 40-hour week, you forgo $400 labor income on your next best job. If you're earning only $300 per week profit, staying in business costs you more than you earn. If you're rational, you'll close down your business eventually and get a job with someone else.8. Imagine you're the manager of a small textile factory that has two product lines—flannel and corduroy. Some workers and some machines are specialized in the production of only one of these goods. The maximum amount of flannel that can be produced is 1,500 yards per month, with 10,000 labor hours per month. You can't vary the number of machines or amount of floor space in the factory. Suppose you're currently producing at an efficient level. If monthly orders drop to 1,000 yards of corduroy and 1,000 yards of flannel, what could you do to reduce costs during the month? Answer: Your current orders correspond to a point inside your existing production possibilities curve that prevails, given your current plant size and labor force. By laying off workers, you can reduce costs. With a small labor force, your production possibilities curve will shrink inward toward the origin. You can lay off workers until your current level of production for 1,000 yards of flannel and 1,000 yards of corduroy correspond to a point on the new production possibilities curve.9. Your younger sister receives a weekly allowance of $20, which she spends entirely on nail polish and candy bars. Nail polish costs $4 per bottle, and candy bars are $1. Describe your sister’s budget line. What is the opportunity cost of a bottle of nail polish? Would the opportunity cost of nail polish changeif the prices of nail polish and candy bars doubled?How will the budget line shift for each of the following changes? Calculate the opportunity cost of each item, for each change.a. An increase in the


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