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Factors of Production and the PPC Diagram: Question 8

Syllabus 1.4

Structured 7 marks

The economy of Meridia produces only two goods, rice (measured in tonnes per year) and furniture (measured in units per year). The table below shows three combinations of output, W, X and Y, that all lie on Meridia's production possibility curve (PPC), each representing full and efficient use of Meridia's resources.

Point Rice (tonnes) Furniture (units)
W 0 500
X 200 400
Y 350 250

(a) Calculate the opportunity cost, in units of furniture given up per tonne of rice gained, of moving from point W to point X. [2]

(b) Calculate the opportunity cost, in units of furniture given up per tonne of rice gained, of moving from point X to point Y. [2]

(c) Using your answers to (a) and (b), explain what happens to the opportunity cost of producing extra rice as Meridia produces more and more of it, and suggest why this pattern might occur. [3]

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Worked solution

Part (a): Opportunity cost of moving from W to X

Moving from point W to point X is a movement along the same PPC.

Rice gained: 200−0=200 tonnes200 - 0 = 200 \text{ tonnes}

Furniture given up: 500−400=100 units500 - 400 = 100 \text{ units}

Opportunity cost per tonne of rice: 100200=0.5 units of furniture\frac{100}{200} = 0.5 \text{ units of furniture}

Part (b): Opportunity cost of moving from X to Y

Rice gained: 350−200=150 tonnes350 - 200 = 150 \text{ tonnes}

Furniture given up: 400−250=150 units400 - 250 = 150 \text{ units}

Opportunity cost per tonne of rice: 150150=1.0 unit of furniture\frac{150}{150} = 1.0 \text{ unit of furniture}

Part (c): Why the opportunity cost of rice rises

Comparing the two results, the opportunity cost of an extra tonne of rice rises from 0.5 units of furniture (moving from W to X) to 1.0 unit of furniture (moving from X to Y), even though all three points lie on the very same, unchanged PPC. This is not a shift of the curve, only movement along it.

This pattern is most likely explained by the fact that Meridia’s land, labour and capital are not all equally well suited to producing both rice and furniture. At low levels of rice output, the resources first switched out of furniture production (from W to X) may be resources that were relatively better suited to growing rice, for example fertile farmland, so relatively little furniture output has to be sacrificed. As rice output expands further (from X to Y), Meridia is forced to switch resources that are progressively less well suited to rice and relatively better suited to furniture, for example skilled furniture-makers or workshop machinery, so each extra tonne of rice now costs more forgone furniture than before.

Final answers

  • (a) Opportunity cost of W to X = 0.5 units of furniture per tonne of rice
  • (b) Opportunity cost of X to Y = 1.0 unit of furniture per tonne of rice
  • (c) The opportunity cost of extra rice rises along the same PPC because Meridia’s resources are not equally suited to producing both goods, so progressively less rice-suited resources must be switched into rice production as output expands.