Production Possibilities for Australia and Canada - Assignment Example

Question 1 a) “Since I own my own home, housing costs me nothing” This statement is not true, mainly because owning a home does not eliminate the costs associated with housing. Typically, the benefits of owning a home may outweigh that of renting. Many people believe that by owning a home their housing costs are eliminated. However, believe is not actually the case. There are several benefits associated with owning a home. These include; increase in the value of the house, greater privacy, and predictable cost as well as a sense of pride from home ownership. Nevertheless, despite owning a home, there will always be housing costs to incur. An individual may have mortgaged the house. Therefore, regular mortgage payments are required to be made to offset the mortgage. In most cases the mortgage payments are usually higher compared to rent payments. In addition, these mortgage payments are financial commitments that have to be met, failure to which banks may take away the house from the owner. Furthermore, the owner of a home is also responsible for all the maintenance and repairs for the house. Some of these maintenance costs may be high, while others maintenance and repairs may be relatively inexpensive. b) “These lectures are boring and useless, but since I have paid for them, I am going to attend all of them”. Some students in institution of learning may find certain lectures boring and useless. Consequently, they may be tempted to boycott such lectures, because they believe they will not benefit from attending the perceived boring lectures. However, since these students have paid for the lectures in form of tuition fee, they are compelled to attend the lectures to satisfy their need to utilize the tuition fee already paid. There are several reasons why students may find certain lectures boring and useless. These reasons include; ineffective teaching methods, long lecturing hours, type and level of difficulty of the subject being studied, and the perceived relevance of the course in the practical world. Nevertheless, the lectures may not be as useless as perceived by the students. Therefore, the student who attends the lectures out of necessity for having paid for them in the end will learn something out of lectures compared to the student who boycotts the lectures completely just because they find the lectures boring and useless. c) “Petrol is essential for people who own motor vehicles; therefore the demand curve for petrol is perfectly inelastic”. Typically, goods and services which are essential are considered to be characterized by perfectly inelastic demand. This is mainly because changes in prices do not affect the demand of the good or service, since people will still demand for the same quantity of the good or service. Petrol is an essential commodity for people who own motor vehicles. Therefore, changes in prices of petrol will not affect the quantity demanded for petrol. This is because for these people to go to work or continue with their daily routine and activities they will need the same quantity of petrol regardless of the changes in petrol prices. Ideally, the demand for petrol is expected to be perfectly inelastic, which usually it is in the short run because people just buy the petrol. However, in the long run, the elasticity of demand for petrol will tend to change over time. This is because as a result of increasing petrol prices people will tend to buy more fuel efficient cars or some even buy bicycles. Hence, the elasticity of the demand of petrol will tend to be more elastic over time. Question 2 Production possibilities for Australia and Canada are as illustrated in the table below. Production per day (Australia) Production per day (Canada) Cheese Wine 1600 OR 3200 800 OR 2400 a) The production possibility frontiers for Australia and Canada are as illustrated in figure 1 and figure 2 respectively. Figure 1 Figure 2 b) Absolute advantage refers to the ability of a country to produce more goods or service than another country using the same amount of resources. Australia produces more cheese and wine than Canada in a day. Therefore, Australia can be said to have an absolute advantage over Canada in the production of cheese and wine. c) To determine which of the two countries has a comparative advantage in the production of wine, the opportunity cost for the production of wine is established. In Australia, either 3200 units of wine or 1600 units of cheese can be produced. Therefore, the opportunity cost of producing a unit of wine in Australia is 0.5 unit of cheese. Similarly, in Canada, either 2400 units of wine or 800 units of cheese can be produced. Thus, the opportunity cost of producing a unit of wine in Canada is 0.33 unit of cheese. As established the opportunity cost for producing wine in Canada (0.33) is smaller than that in Australia (0.5). Therefore, Canada has a comparative advantage in the production of wine. On the other hand, the opportunity cost of producing a unit of cheese in Australia is 2 units of wine. Similarly, the opportunity cost of producing a unit of cheese in Canada is 3 units of wine. Hence, the opportunity cost for producing cheese in Australia (2) is smaller than that in Canada (3). Therefore, Australia has a comparative advantage in the production of cheese. d) The opportunity cost for producing a unit of cheese in Australia is 2 units of wine, while the opportunity cost of also producing a unit of cheese in Canada is 3 units of wine. Given that the opportunity cost is constant in the two countries, the opportunity cost of producing a unit of cheese in the Australia and Canada is 2.5 units of wine. Therefore, the terms of trade 1 unit of cheese = 2.5 units of wine will be quite acceptable in the two countries. The consumption and production possibility frontiers for Australia and Canada are as illustrated in figure 3 and figure 4 respectively. Figure 3 Figure 4 The consumption possibilities frontiers indicated above are based on the terms of trade between the Australia and Canada (1 cheese unit = 2.5 wine units). As established, Australia has a comparative advantage in cheese production. Therefore, if it were to export all the cheese it can produce, it would exchange it for 4000 units of wine (1600 x 2.5 = 4000) as indicated in figure 3. On the other hand, Canada has a comparative advantage in wine production. Therefore, if it were to export all its wine to Australia it would exchange it would exchange it for 960 units of cheese (2400 x 0.4 = 960) as indicated in figure 4. e) As indicated in the production and consumption possibility frontiers in (d) above, trade increases the welfare in the two countries. When Australia specializes in producing the cheese which it has comparative advantage and enter into trade with Canada specializing in wine production, which it has comparative advantage, both the two countries will be left better off prior to the trade. This is because as illustrated in the production and consumption possibility frontiers in (d) above, the trade will allow both Australia and Canada to reach levels in the PPF that was originally unattainable. Question 3 a) The reduction in tax on retail price of petrol will subsequently lead to the decrease in the retail price of petrol. Therefore, if the tax on petrol is reduced by 5 cents, the retail price of petrol will reduce relatively by 5cents from $1.50 to $1.45. b) Using the mid-point method, the elasticity of demand of petrol is determined as follows; c) The revenue collected before and after the tax cut is as follows; (i) Tax revenue before tax cut = Quantity demanded x tax Tax revenue before tax cut = 18 billion litres x $0.38 Tax revenue before tax cut = $6.84 billion (ii) Tax revenue after tax cut = Quantity demanded x tax Tax revenue after tax cut = 18.06102 billion litres x $0.33 Tax revenue after tax cut = $5.96 billion d) The dead weight loss from the petrol tax when the tax is reduced by 5 cents is as follows; Dead weight loss = 0.5(Q2-Q1) (P2-P1) Dead weight loss = 0.5(61.02 million litres) (0.05) Dead weight loss = 0.5 x 61.02 million litres x $0.05 Dead weight loss = $1.5255 million Dead weight loss = $1,525,500 per year e) The ratio between the change in revenue in c and the change in dead weight is as follows; Change in tax revenue = ($6.84 -$5.96) billion Change in tax revenue = $0.88 billion Change in tax revenue = ($0.88 x 1000) million Change in tax revenue = $880 million Dead weight loss = $1.5255 million Ratio= $1.5255/ $880 Ratio= 0.0017 The deadweight loss ratio evaluates the relative efficiency of tax. As established the deadweight ratio is relatively small (0.0017). This implies that each dollar raised in tax revenue caused approximately $0.0017 of deadweight loss. Question 4 The industrial production (price, Quantity, MC, MEC and MSC) of a chemical, which produces negative externalities, is as indicated in table below; Price (dollars per tonne) Quantity (tonnes per day) MC= MEC (dollars per tonne) MSC = 2 x MC (dollars per tonne) 0 6000 120 240 40 5000 100 200 80 4000 80 160 120 3000 60 120 160 2000 40 80 200 1000 20 40 a) With no regulation and pollution control; Quantity of chemical produced = 4000 tonnes per day Price of the chemical produced = $80 per tonne Marginal external cost of the pollution generated = $80 per tonne b) With no pollution control; Marginal social cost (MSC) of the chemical produced = $160 per tonne Dead weight loss = 0.5x (1000 tonnes) x 80 Dead weight loss = $40,000 per day c) If the government levies taxes on producers to enable market produce at efficient quantity; Price of the chemical per tonne = $120 Tax per tonne = MSC – MC Tax per tonne = $120 - $60 Tax per tonne = $60 Tax revenue = Efficient quantity produced x tax per tonne Tax revenue = 3000 tonnes x $60 Tax revenue = $180,000 d) The diagram to illustrate the market factors of the industrial production of the chemical is as follows; Figure 5 e) Environmental protection agency regulations: Besides the use of taxation, there are other ways to deal with the negative production externalities. This is mainly because if the imposed tax is cheaper than the alternative production method which causes pollution, then the pollution problem will not be dealt with. Therefore, regulations through environmental protection agencies can be used to set the limit of pollution that a firm can legally emit. Hence, this is another way that the negative production externalities can be dealt with. Question 5 a) The supply and demand curve of the unregulated taxi ride market is as illustrated in the following diagram. As indicated the market equilibrium in the unregulated market is 5000 rides per day. Figure 6 b) Also indicated in the demand and supply curve for the unregulated taxi ride market is the consumer surplus and producer surplus. In a given market, consumer surplus is usually derived when the actual market price of a good or service is less than the amount the consumer is willing to pay for the same good or service. On the other hand, producer surplus is benefit or gain to producers usually in terms of profits and it occurs when the market price of their produce in the higher than the amount they were willing to receive for their produce. c) The supply curve (S2) of the regulated taxi ride market is as illustrated in the following diagram. As indicated, as a result of the government regulation on the taxi ride market, the supply curve of the taxi ride per day shifts to the left from S1 to S2. Figure 7 d) As indicated in the demand and supply curve above, the equilibrium price (P2) of the regulated taxi ride market is higher than the equilibrium price (P1) of the unregulated taxi ride market. However the equilibrium quantity (Q2) of the regulated market is lower than the equilibrium quantity (5000 taxi rides) of the unregulated market. e) The consumer surplus and producer surplus under the regulated market are also indicated in the demand and supply curve of the regulated taxi ride market. In addition, as a result of the government regulation on the taxi ride market there is a dead weight loss. This is also appropriately indicated in the demand and supply curve of the regulated taxi ride market indicated above. Read More