Production Possibility Frontier free essay sample

The Production possibility frontier analyses the most efficient use of company resources to achieve different levels of production of output. Labour is one of the variables factors of production. One unique feature of the PPF is that one alternative is usually foregone in order to maximize the production of another product, for example, in a refinery a manager may decide to deploy more human resources to produce more lubricant products than insecticides based on maybe the forces of demand and supply. A constant return to labour (CRL) occurs when the opportunity cost of the production of lubricants is constant. This is not always the case. Return to labour can decrease or increase. Decrease in return to labour may be as a result of equipment downtime as a result of overuse. Increase in return to labour may also occur and could be due to increased capability (training) or technology. Output (Lubes) 500 400 300 200 100 Labour input 100200300 Figure 1. PPF under IRL and DRL Figure 1 shows production function under increasing and decreasing return on labour. In IRL, each addition of labour input sees an increase in output whereas in DRL, the average output decreases with the extra unit of input; in other words, the labour input is not productive. Your explanation discusses the concepts of increasing and decreasing returns to labour and the relationship with opportunity cost but your answer could have been enhanced by making use of a production possibilities frontier diagram as illustrated in the specimen answer. Question 3 Many firms experience IRL at low levels of output and DRL when output increases. Draw the production function for a business where IRL prevails when Q lt; Qc and DRL when Q gt; Qc. Output 800 600 400 200 Average total cost Labour input 10050010001,200 Using the figures in Table 5. 4. 2 of the lesson notes, in DRL, average fixed cost falls at low levels of output while average variable cost increases as output increases. This is due to the falling efficiency of labour. In IRL, average fixed cost and average variable cost reduces when output increases and this is due to the efficiency of labour. Your are correct in your explanation of the impact of DRL and IRL on costs but you haven’t taken account of that part of the question which asks you about the production function where IRL prevails below Qc and DRL prevails above Qc. Question 4 On the graph below, identify the average total cost curve. Name the other curves. The average total cost curve is curve 2 Curve 1 is short-run marginal cost (SRMC) Curve 3 is short-run average variable cost (SRAVC) Curve 4 is the Short-run average fixed cost Correct! Question 5 a. What determines the steepness of the SRATC curve below Q* in Lesson 5, Figure 5. . 2 and hence the vulnerability of a business? The steepness of the SRATC curve is determined by the factors that cause types 1 and 2 vulnerabilities viz: size of the fixed cost component of the total cost; the dependence on high human capital costs as well as the high bought-in goods. These factors might cause a business to drop its level of output, from Q* to Q1. As a result the average total cost will rise thereby minimizing profit and profit margin. The higher the impact of the shock on the average total cost, the steeper the SRATC curve and hence the more vulnerable the business is. Note that Fig 5. 4. 2 is considering the short run average total cost curves under DRL so decreasing returns to labour must be taken into account here. What the fig appears to show is that average fixed costs fall as output increases up to an output of Q* but as more variable costs are incurred the average costs rise because of the increase in average variable costs. I think it would be helpful to check back on lesson note 5 and review the specimen answer b . Do you think vulnerability is the same if Q gt; Q* If not why not? Q* and C* represent the point at which average cost and output are maximized. Do you mean that C* represents the point at which average total costs and marginal costs are minimized? An increment in output to Q2 increases the average total cost to C1 which squeezes the profit and profit margin thereby making the business vulnerable. c. What do you think the SRATC curve looks like for i. British Airways (or any airline) The SRATC curve for an airline business is very steep i. e. ‘F’ type curve as it is very vulnerable to shock with its investment in fixed cost and human capital cost. It is also prone to type 2 vulnerability as changes in price of oil are very likely to affect its business. Okay but what happens when the all the flights are full at Q1 ii. Man AG (a German manufacturer of commercial vehicles) This also has a very steep SRATC curve because of its huge investment in heavy duty machines and large human capital cost. The cost of the raw material for its components also makes it prone to type 2 vulnerability. Okay but note the point in the specimen answer about the impact of DRL iii. Tiscali (An internet service provider) This is also vulnerable to external shock because of its dependence on large human capital cost which they have to spend money to up skill and retain. Tiscali will be affected by type 1 vulnerability as its employees and their knowledge base are its biggest asset. What about T2 vulnerability due to increased labour costs as noted in the specimen? iv. a local window cleaner in Leamington Spa. The SRATC curve for this business is flat as any rise to its average total cost does not greatly affect the profit and profit margins. It is a type ‘S’ SRATC curve. This business is faces a type 2 vulnerability as its bought-in costs are its major source of worry. What bought in costs do you have in mind here? What are the window cleaner’s fixed costs: his ladders, bucket, bike/van which are all relatively modest? What are his variable costs? Any labour he employs, his fuel for the car, his cleaning fluids etc? All these costs are modest: he/she doesn’t seem very vulnerable on account of his costs as you suggest. If families cut back on their budgets and clean their own windows of course he/she becomes very vulnerable!