Wk 2 - Demand and Willingness to Pay

What is a combined PPF?

A frontier showing the maximum output combinations achievable by two or more producers together.

How do you find a combined PPF's maximum output of one good?

Add each producer's maximum output of that good.

Who should switch production first when an economy wants more of good X?

The producer with the lowest opportunity cost of X.

Why can a combined PPF have a kink?

The lowest-opportunity-cost producer reaches full capacity, so another producer must switch production.

Why does a combined PPF become steeper as more of the horizontal-axis good is produced?

Increasingly higher-opportunity-cost producers must switch to that good.

Producer A makes at most 8 pepper mills or 8 salt shakers; B makes 2 pepper mills or 4 salt shakers. What are the combined PPF intercepts?

10 pepper mills or 12 salt shakers.

A's opportunity cost of 1 pepper mill is 1 salt shaker; B's is 2. Who switches to pepper mills first?

A, because A sacrifices fewer salt shakers.

A can make up to 8 pepper mills at a cost of 1 salt shaker each; B's cost is 2 salt shakers each. What happens after A makes 8?

B must take over additional pepper-mill production, increasing the opportunity cost.

Does opportunity cost include the value of every alternative you give up?

No. Only the next-best forgone alternative counts.

What is a sunk cost?

A cost already incurred that cannot be recovered regardless of the current decision.

Should sunk costs influence future economic decisions?

No. They cannot be changed, so focus on future costs and benefits.

A company spent $5,000 on advertising last year. Is this a sunk cost today?

Yes. The money is already spent and cannot be recovered.

Is the cost of a business meeting scheduled for next week a sunk cost?

No. It is a future cost, not an already-incurred cost.

A factory paid a non-refundable deposit last month. Is it a sunk cost?

Yes, provided it cannot be recovered regardless of the decision made now.

Why can resting or sleeping have an opportunity cost?

Time is scarce and could have been spent on another valued activity.

Billy makes 4 cakes or 2 donuts/hour; Sally makes 6 cakes or 2 donuts/hour. Who has absolute advantage in donuts?

Neither. Both produce 2 donuts per hour.

Billy makes 4 cakes or 2 donuts/hour; Sally makes 6 cakes or 2 donuts/hour. Who has comparative advantage in cakes?

Sally, because her opportunity cost per cake is lower.

Billy makes 4 cakes or 2 donuts/hour; Sally makes 6 cakes or 2 donuts/hour. Who has comparative advantage in donuts?

Billy, because he sacrifices fewer cakes per donut.

Billy makes 4 cakes or 2 donuts/hour. What is his opportunity cost of 1 cake?

0.5 donut.

Sally makes 6 cakes or 2 donuts/hour. What is her opportunity cost of 1 cake?

1/3 of a donut.

A seller's cost of 1 cake is 1/3 donut; a buyer's cost is 1/2 donut. What trade price benefits both?

Between 1/3 and 1/2 donut per cake.

Why must a mutually beneficial trade price lie between both parties' opportunity costs?

The buyer must pay less than their own cost, while the seller must receive more than theirs.

If the trade price exactly equals one party's opportunity cost, does that party strictly gain?

No. That party is indifferent between trading and producing the good themselves.

What is the main production benefit of specialising according to comparative advantage?

It allows resources to be allocated more efficiently, potentially increasing total output.

What is the difference between production and consumption after trade?

Production is what someone makes; consumption is what they keep or obtain after trading.

Can specialisation increase total output without making every individual better off?

Yes. Greater total efficiency does not guarantee an equal or beneficial distribution for everyone.

What is market demand?

The total quantity demanded by all consumers at each possible price.

How do you combine individual demand curves into market demand?

Horizontally add the quantities demanded at each price.

Why do you multiply individual demand by the number of consumers of that type?

Because market demand includes every consumer, not just one representative person.

What is the choke price?

The price at which a consumer's quantity demanded reaches zero.

What happens if a demand equation gives a negative quantity at a particular price?

Treat that consumer's quantity demanded as zero, not a negative number.

Why does a market demand curve develop kinks?

Different consumer types enter or leave the market at their choke prices.

For Q = 12 − 2P, what is the choke price?

P = 6, found by setting Q = 0.

Consumer A has Q = 6 − P and B has Q = 10 − 2P. At what price does market demand kink?

P = 5, when consumer B's demand reaches zero.

Two consumers each have qA = 12 − 2P; two others each have qB = 14 − 3P. Find market demand at P = 4.

12 units: Type A contributes 8 and Type B contributes 4.

At P = 4, nine consumers each have qA = 10 − 2P, and two have qB = 9 − 3P. Find market demand.

18 units. Type A contributes 18; Type B's negative result is treated as zero.

What is willingness to pay (WTP)?

The maximum amount a consumer is prepared to pay for a good or service.

How does willingness to pay relate to an individual demand curve?

Demand reflects the quantities a consumer values enough to buy at different prices.

A consumer's WTP is $20. Would they voluntarily buy the same item for $25?

No. The price exceeds their maximum willingness to pay.

How can economists estimate the value of non-market benefits, such as civic pride?

By estimating how much people would be willing to pay for those benefits.

Why should economic benefit estimates for major public projects be interpreted carefully?

They depend on assumptions, valuation methods and uncertain estimates of benefits.