Question

2. Production Possibilities: (a) Suppose an economy produces food and housing. Draw and explain the char- acteristics of its production possibility curve. Explain the impact of (i) a new technology that improves food production and (ii) a new invention that improves both food and housing production. (b) Explain how improvements in education may shift an economy's production pos- sibility frontier. (c) Consider the following three uses of government spending: the purchase of a nu- clear weapon, a “hot meals" program for the elderly, and a job training program for the unemployed. Which of these would be most likely to succeed in shifting out an economy's production possibility frontier? Explain your answer. 3. Price Controls: Many have argued that the problems of poverty can be alleviated through the use of controls in labor and housing markets. Consider the following two types of controls. (a) Consider the market for housing in an inner-city. Suppose the current equilib- rium rent is $1000 per month for an apartment. Draw this market. In order to make housing more affordable, the city has enacted a rent control mandating rents be fixed at $700 per month. Explain who benefits and who loses from this legislation. What are the long-term effects from the standpoint of consumers and producers? How will the market for rental housing change over time? Has the policy met its goal of fighting poverty? That is, do you think the price-elasticity of demand individual in a LDC is greater than or less than that of a person living in Canada?

Answer 1

2) production possibilities

A production possibility frontier (PPF) or production possibility curve (PPC) is a graphic representation which shows various combinations of the amounts of two goods which can be produced within the given resources and technology. Here we assume the two resource to be housing and food.

The following figure shows a PPC

Housing (number Fead (Quantit

Fig 1.

As can be seen in figure 1 , the slope of PPC negative, which due to the tradeoff faced . Since the resources in an economy is scare , increasing the production of a kind of good ,say housing ,is possible by shifting the factors of production from the production of the other good ,say food. Therefore as production of a product is increased , the production of other product has to be decreased.

The slope of the PPC also diminishes in absolute value , as the factors of production are shifted more and more from the production of a product , say housing , to production of food , factors becomes less and less productive as every next factor being shifted is less suitable for other product.

This is called diminishing marginal rate of transformation.

The marginal rate of transformation (MRT) is the number of units or amount of a good that must be forgone in order to create or attain one unit of another good.

i) any factor that causes change in the efficiency of factors of production or leads to change in productivity will shift the PPC. Improved technology increases productivity hence will shift the curve outward.

Housing (Nomber) foods (Quan

Fig 2

ii) the new invention will affect the PPC in the same way as it increases productivity. PPC will shift outward as shown in fig 2

b) improvement in education leads to increase in productivity of the human resource therefore it will shift the PPC outward as in fig 2

c) the purchase in nuclear weapon does not affects the productivity of the factors and therefore there will be no affect on PPC.

'Hot meals' program will surely benefit the elderly and is a kind act but it does not affect the PPC . Elderly are out of labour force , therefore they do not constitute factor of production or human resource.

Training unemployed will shift the PPC outward as it leads to use of economy's idle resources.

3) Price controls

Price controls fails to mitigate poverty. Rather, it brings distortion in market mechanism.

The affect of decrease in monthly wages is shown in fig 3

a hentes $ 1000 – – if I as Houses (numbers)

Fig 3

SS is the supply curve for the houses offered for rent

DD is the demand curve for the rental house

As can be seen, at $1000 , quantity demanded was equal to quantity sold . But at government imposed price , the quantity demanded is more than quantity supplied . Quantity supplied decrease as less house owners offer their house for rent at lower price and quantity demanded increases as the more consumers with lower reservation price than $1000 also enters the market.

This shortage leads to a host of related distortions. For example, since there is a queue of people willing to rent each house and landlords are not permitted to discriminate based on price, the landlords will discriminate on whatever characteristic they please. Landlords may also ask for under‐​the‐​table payments from tenants or require renters to hand over an initial fee in order to sign the lease.

The only people who gains are those who have lower reservation price for rent than $1000 and are somehow able to get through these new forms of discrimination which landlords imposes , as quantity supplied is lesser than demanded.

In long term , price controls will lead to black market , where the landlord would rather charge the equilibrium price informally and illegally and there would be people willing to pay that price to rent room .

Thus ultimately creating an ' underground ' market for rentals.

Poverty is not at a affected by this policy.

b) Affect of minimum wage is similar . It also disrupts the market mechanism. The number of people willing to offer their labour at $15 will increase whereas the requirement of employees to recruit will decrease as wage increases.

As shown in fig 4

LS > LD SL - wagesis 1 Labour (in number)

Fig 4

Labour seeking employment at prevailing wage $15 but not getting employed increases i.e. unemployment increases.

Infact the employers shed off some of its labour whom it was paying lesser than $15 , creating more unemployment.

The long run impact can be seen in terms of increase in discouraged labour, decreased labor market experience and accumulation of tenure.

c) No, these policies do not have desired affect.

These policies are catchy . They have strong mass appeal ability and that is why they are popular.

As been discussed in part b ,from Economic point of view these policies are ineffective and no where near equitable .

d) policies which strengthen supply side in the case of housing would help. For example lower rate of interest on housing loans can lead to construction of more houses leading to shift in supply curve. As the quantity supplied increases, the price will decrease itself through market mechanism.

In case of labour market, anything that can increase the marginal productivity of labour would work . For example , skill training , affordable education could increase the efficiency of labour . This would lead to higher production at lesser cost and hence more profit . Employer will happily increase wages themselves.