Production Possibility Frontier

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Question 2
Show the PPF curve under decreasing and increasing returns to labour.

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 < Qc and DRL when Q > 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 5.4.2 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...
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