Question

5. Suppose an economy can produce two goods, A and B. It is now operating at point E on production possibilities curve RT. An improvement in the technology available to produce good A shifts the curve to ST, and the economy selects point E'. How does this change affect the opportunity cost of producing an additional unit of good B?

Answer 1

5. The opportunity cost is basically the slope of the production possibility frontier/curve (PPF), and in case of opportunity cost of good B, it can be defined as , ie change in production of A for a unit increase in B. The slope is negative in magnitude, showing that increase in production of B would lead to decrease in production of A.

The opportunity cost is basically the slope of the production possibility frontier/curve (PPF), and in case of opportunity cost of good B, it can be defined as�dA/dB, ie change in production of A for a unit increase in B. The slope is negative in magnitude, showing that increase in production of B would lead to decrease in production of A. In the case stated, the improvement in technology to produce A leads to increase in production of A for all combinations, shifting the curve to ST, and T remains the same as improve in that technology doesn't affect its production. The economy goes from E to E', choosing same amount of B as before, but more amount of A. It can be seen that if a slope is drawn on the points, the slope of ST at E' is steeper than the slope of RT at E, as below. This means that the slope at E' is more than

In the case stated, the improvement in technology to produce A leads to increase in production of A for all combinations, shifting the curve to ST, and T remains the same as improve in that technology doesn't affect its production. The economy goes from E to E', choosing same amount of B as before, but more amount of A. It can be seen that if a slope is drawn on the points, the slope of ST at E' is steeper than the slope of RT at E, as below.

This means that the slope at E' is more than the slope at E, or can be said that the opportunity cost of producing B is more at E' than opportunity cost of producing B at E. It can be interpreted as, since A is now more easy to produce than B, producing B instead of A would pose more opportunity cost. Hence, the opportunity cost increases.

6. A nations PPF shifts along with change in its determinants. An inward shift is definitely feasible, and would basically state that less of A is produced per amount of B than before. It would mean a decrease in production capacity of one or both goods which would lead to such an inward shift. It may casue because of -

• A natural disaster or a man-made disaster (for ex - war) that destroys production capacity or current capital and/or labour, and hence leads to decrease in production.
• A recession casues decrease in productivity, hence decrease in production.
• A decrease in investment or increase in rigidity of loan market, so that capital is now more costly to be accquired, causes production to be costly and limited, hence decrease in the production.