A Level Economics 5: Production Possibility Frontier

Consider an economy that produces two goods, computers and bicycles. Explain why the PPF is typically drawn as a concave curve to the origin when representing the trade-off between these goods. Additionally, discuss what it means when a PPF is depicted as a straight line and how it relates to perfect factor substitutability.

The PPF is usually drawn as a concave curve to the origin when representing the trade-off between two goods, such as computers and bicycles. This concave shape reflects the concept of imperfect factor substitution.

The concave curve of the PPF signifies that resources used in production are not equally efficient in producing both goods. It suggests that as an economy shifts resources from producing one good to the other, there is a diminishing marginal rate of transformation (MRT). In simpler terms, it means that as more resources are allocated to producing one good, the economy must sacrifice increasing amounts of the other good. This diminishing MRT arises due to factors like specialization, different resource requirements, or technological limitations.

On the other hand, a straight-line PPF represents perfect factor substitutability. In this scenario, resources used in production can be easily switched between producing one good and the other without any loss of efficiency or trade-off. The straight-line PPF indicates that the economy can reallocate resources between the two goods without experiencing diminishing returns or increased opportunity costs.

Perfect factor substitutability implies that the production technology used in the economy allows for seamless and efficient switching of resources between goods. For example, if the production process for computers and bicycles is highly flexible, and resources like labor and capital can be effortlessly shifted, the economy can produce any combination of computers and bicycles along the straight-line PPF without facing any loss in productivity.

However, it is essential to note that in reality, perfect factor substitutability is rare. Most production processes involve specialized resources, different skill sets, and specific technologies, leading to diminishing returns and trade-offs between goods, as represented by the concave shape of the PPF.

In summary, the concave shape of the PPF demonstrates imperfect factor substitution, indicating diminishing returns and trade-offs between goods. A straight-line PPF, on the other hand, signifies perfect factor substitutability, suggesting that resources can be interchanged without any loss in productivity or trade-offs between goods.

Economics Essay 75: Cross Elasticity of Demand

Explain how the concept of cross elasticity of demand can be used to understand the relationship between markets.

The concept of cross elasticity of demand measures the responsiveness of the quantity demanded of one good to changes in the price of another good. It helps us understand the relationship between markets and the degree of substitutability or complementarity between different products. Here are a few examples of how cross elasticity of demand can be used to understand market relationships:

1. Substitutable Goods: When the cross elasticity of demand between two goods is positive, it indicates that the goods are substitutes, meaning consumers can easily switch between them in response to price changes.

Example: Coffee and tea are often considered substitutes. If the price of coffee increases, consumers may choose to switch to tea, leading to a higher demand for tea. The cross elasticity of demand between coffee and tea would be positive.

2. Complementary Goods: When the cross elasticity of demand between two goods is negative, it suggests that the goods are complements, meaning they are typically consumed together, and a change in the price of one affects the demand for the other.

Example: Cars and gasoline are complements. If the price of cars decreases, it is likely to increase the demand for cars, which, in turn, increases the demand for gasoline. The cross elasticity of demand between cars and gasoline would be negative.

3. Independent Goods: When the cross elasticity of demand between two goods is close to zero, it indicates that the goods are independent of each other. Changes in the price of one good have little to no impact on the demand for the other.

Example: The cross elasticity of demand between smartphones and toothpaste is likely to be close to zero since there is no significant relationship or substitutability between them.

By analyzing the cross elasticity of demand, businesses can make informed decisions about pricing, marketing strategies, and product development. It helps them understand the impact of price changes in related markets and the potential for capturing market share from substitute goods. It also assists policymakers in assessing market relationships and potential market failures.

One group of people can’t substitute their way out of inflation

Tim Harford in The FT

In a laboratory in College Station, Texas, in 1990, six lab rats pressed levers and lapped at tubes as root beer and tonic water were released. They were participating in the quest for an elusive quarry: the Giffen good. 

Robert Giffen was born in Lanarkshire in 1837, the year of Queen Victoria’s accession. He would become by turns assistant editor at The Economist, chief statistician at the Board of Trade, President of the Royal Statistical Society and co‑founder of the Royal Economic Society. An eminent Victorian indeed, even if one biographer sniffed, “He was one of those figures . . . whose not inconsiderable power and prestige appears to be disproportionate to their actual contribution to economic science.” Ouch. 

Yet Giffen’s name is known to every economics student. This is not because of the research he published, but because of a thought experiment which reached his contemporary Alfred Marshall, who put it in his inescapable textbook Principles of Economics. The idea is that certain goods might be consumed more when their prices rise, because the increased cost backs consumers into a corner. 

Here’s how I imagined it, as an impoverished student. My staple diet was jacket potatoes with cheese or tuna mayo, bought from a nearby kebab van. Imagine that the price of potatoes rose. Ordinarily, I’d be expected to buy fewer potatoes and more of something else. 

The problem is everything else was still more expensive than potatoes. With my budget squeezed, I couldn’t afford the luxury of the cheese and tuna topping. The missing calories would come from . . . more potatoes. 

In this example, potatoes are a “Giffen good”. Potatoes were a major part of my diet; when their price rose, I effectively became poorer and switched towards the cheapest foodstuff. The cheapest foodstuff was potatoes. 

Of course, this did not actually happen. I was never that destitute and never such a potatophage. For about a century, economists looked for real examples of Giffen goods and did not find them until 1990, when economists Raymond Battalio, John Kagel and Carl Kogut demonstrated Giffen behaviour in lab rats. (The lab rats, I am assured, were well looked after by Battalio’s neighbour, a vet.) 

The researchers offered the rats quinine-flavoured water, which the rats disliked, and root beer, which they loved. The effective prices of these drinks were changed by adjusting the volume of drink released each time the rat pressed a lever. Root beer was “expensive” because it was dispensed in smaller portions. And sure enough, it proved possible to provoke Giffen behaviour: when the cheaper quinine water became less cheap, rats still needed a drink and they cut back on the luxury of root beer, drinking more quinine water. 

So are Giffen goods little more than a theoretical curiosity? Not quite. Eventually, the economists Robert Jensen, Nolan Miller and Sangui Wang used both public health data and a field experiment to demonstrate that in the poorest parts of Hunan, China, rice was a Giffen good. As Jensen wrote in 2008, “It’s funny that people have looked in crazy places for Giffen behaviour . . . and it turns out that it could be found in the most widely consumed food in the most populous nation in the history of humanity.” 

Giffen goods also teach us something important about the impact of price rises on the poorest people. One of the most basic lessons of economics is that people respond to price hikes by finding cheaper options. If apples are expensive this week, buy oranges; when the price of oranges rises and the price of apples falls, switch back to apples again. Or just look for the bargain-basement option. If a West End show is too expensive, go to the cinema. If the cinema costs too much, watch television. You don’t have to pay higher prices; you can make do with a cheaper alternative. 

Inflation is always a little lower than it seems once you allow for such substitutions. But one group of people can’t play that game: those who are already relying on the cheapest staples have nowhere to run from price rises. 

So it wasn’t quinine water in a Texas laboratory, or rice in Hunan, that made me think recently of Giffen goods. It was the alarming rise in the price of a cheese salad sandwich. The latest data from the UK show that sliced white bread has risen in price by 29 per cent over the past 12 months, with tomatoes up 16 per cent, butter up 30 per cent, cheddar cheese up 42 per cent and cucumber 55 per cent more expensive. (Headline inflation, meanwhile, is just over 10 per cent.) 

I am not claiming that cheddar cheese is essential to life; it just seems that way. Nor is it a Giffen good. But basic foodstuffs are Giffen-adjacent. They are the last resort of people who cannot afford fancier stuff. 

Food poverty campaigners — most prominently Jack Monroe — have argued that the price of these basics has risen much faster than the general rate of inflation. As I’ve written before, it’s hard to be sure if that’s true. The Office for National Statistics tends to focus on the most popular products, not the cheapest bargains, and so the relevant data is patchy and experimental. 

Whether or not inflation really is higher for the poorest households, what is not in doubt is that inflation hits them hardest. That is both because they are more vulnerable, and because they have less room for manoeuvre as they ponder their options in the supermarket aisle. The Bank of England’s chief economist, Huw Pill, recently said that, “We’re all worse off.” Maybe so. But some of us are worse off than others.

The Economist's Concubine

Robert Skidelsky in Project Syndicate


In recent decades, economics has been colonizing the study of human activities hitherto considered exempt from formal calculus. What critics call “economics imperialism” has given rise to an economics of love, of art, of music, of language, of literature, and of much else.

The unifying idea underlying this extension of economics is that whatever people do, whether it is making love or making widgets, they aim to achieve the best results at the least cost. These benefits and costs can be reduced to money. So people are always looking for the best financial return on their transactions.

This is contrary to the popular separation of activities in which it is right (and rational) to count the cost, and those in which people do not (and should not) count the cost. To say that affairs of the heart are subject to cold calculation is, say the critics, to miss the point. But cold-hearted calculation, reply the economists, is exactly the point.

The pioneer of the economic approach to love was the Nobel laureate Gary Becker, who spent most of his career at the University of Chicago (where else?). In his seminal paper, “A Theory of Marriage,” published in 1973, Becker argued that selecting a partner is its own kind of market, and marriages occur only when both partners gain. It’s a very sophisticated theory, relying on the complementary nature of male and female work, but which tends to treat love as a cost-reducing mechanism.

More recently, economists such as Columbia University’s Lena Edlund and University of Marburg’s Evelyn Korn, as well as Marina Della Giusta of Reading University, Maria Laura di Tommaso of the University of Turin, and Steiner Strøm of the University of Oslo, have applied the same approach to prostitution. Here, the economic approach might seem to work better, given that money is, admittedly, the only relevant currency. Edlund and Korn treat wives and prostitutes as substitutes. A third alternative, working in a regular job, is ruled out by assumption.

According to the data, prostitutes make a lot more money than women working in ordinary jobs. So the question is: why is there such a high premium for such low skills?

On the demand side is the randy male, often in transit, who weighs the benefits of going with prostitutes against the costs of getting caught. On the supply side the prostitute will require higher earnings to compensate for her higher risk of disease, violence, and blighted marriage prospects. “If marriage is a source of income for women,” write Edlund and Korn “then the prostitute has to be compensated for foregone marriage market opportunities.” So the premium reflects the opportunity cost to the prostitute of performing sex work.

There is a ready answer to the question of why competition does not drive down sex workers’ rewards. They have a “reservation wage”: If they are offered less, they will choose a less risky line of work.

What warrant does the state have to interfere with the contracts that are struck within this market of willing buyers and sellers? Why not decriminalize the market altogether, as many sex workers want? Like all markets, the sex market needs regulation, particularly to protect the health and safety of its workers. And, as in all markets, criminal activity, including violence, is already illegal.

But on the other side, there is a strong movement to ban buying sex altogether. The so-called Sex Buyer Law, criminalizing the purchase, though not the sale, of sexual services has been implemented in Sweden, Norway, Iceland, and Northern Ireland. The enforced reduction of demand is expected to reduce supply, without the need to criminalize the supplier. There is some evidence that it has had the intended effect. (Though supporters of the so-called Nordic System ignore the effect of criminalizing the purchase of sex on the earnings of those who supply it, or would have supplied it.)

The movement to ban buying sex has been strengthened by the growth of international trafficking in women (as well as drugs). This may be counted as a cost of globalization, especially when it involves an influx into the West from countries where attitudes toward women are very different.

But the proposed remedy is too extreme. The premise of the Sex Buyer Law is that prostitution is always involuntary for women – that it is an organic form of violence against women and girls. But I see no reason to believe this. The key question concerns the definition of the word “voluntary.”

True, some prostitutes are enslaved, and the men who use their services should be prosecuted. But there are already laws on the books against the use of slave labor. I would guess that most prostitutes have chosen their work reluctantly, under pressure of need, not involuntarily. If men who use their services are criminalized, then so should people who use the services of supermarket checkout employees, call-center workers, and so on.

Then there are some prostitutes (a minority, to be sure) who claim to enjoy their work. And, of course, there are male prostitutes, gay and straight, who are typically ignored by feminist critics of prostitution. In short, the view of human nature of those who seek to ban the purchase of sex is as constricted as that of the economists. As St. Augustine put it, “If you do away with harlots, the world will be convulsed with lust.”

Ultimately, all arguments against prostitution based on notions of inequality and coercion are superficial. There is, of course, a strong ethical argument against prostitution. But unless we are prepared to engage with that – and our liberal civilization is not – the best we can do is to regulate the trade.

Alcohol without the hangover? It's closer than you think

Science now allows us to develop a safer way to get drunk. But before we can sober up in minutes, the drinks industry needs to embrace this healthier approach

• 
• • David Nutt
  • theguardian.com, Monday 11 November 2013 19.04 GMT

'If alcohol was discovered today it could never be sold as it is far too toxic to be allowed under current food regulations'. Photograph: Action Press/Rex Features

Imagine enjoying a seasonal drink at a Christmas party without the risk of a hangover the next day, or being able then to take an antidote that would allow you to drive home safely. It sounds like science fiction but these ambitions are well within the grasp of modern neuroscience.

Alcohol is both one of the oldest and most dangerous drugs, responsible for about 2.5 million deaths worldwide, which is more than malaria or Aids. The reasons for this are well known: alcohol is toxic to all body systems, and particularly the liver, heart and brain. It makes users uninhibited, leading to a vast amount of violence and is also quite likely to cause dependence, so about 10% of users get locked into addiction. If alcohol was discovered today it could never be sold as it is far too toxic to be allowed under current food regulations, let alone pharmaceutical safety thresholds. In this health-conscious age, it is odd that these aspects of alcohol are rarely discussed.

The only proven way to reduce alcohol harms is to limit consumption through increased pricing and limiting availability. Most governments have shied away from this because of pubic opinion and fears of lost tax income – the notable exception being Scotland with its minimum pricing strategy. An alternative strategy that offers greater health benefits would be to make a safer version of alcohol.

We know that the main target for alcohol in the brain is the neurotransmitter system gamma aminobutyric acid (Gaba), which keeps the brain calm. Alcohol therefore relaxes users through mimicking and increasing the Gaba function. But we also know that there are a range of Gaba subsystems that can be targeted by selective drugs. So in theory we can make an alcohol surrogate that makes people feel relaxed and sociable and remove the unwanted effects, such as aggression and addictiveness.

I have identified five such compounds and now need to test them to see if people find the effects as pleasurable as alcohol. The challenge is to prepare the new drink in a fashion that makes it as tasty and appealing. This is likely to be in the form of a cocktail, so I foresee plenty of different flavours. The other great advantage of this scientific approach to intoxication is that if we target compounds that affect the Gaba system, then it is possible to produce other drugs that could be sold alongside the alcohol substitute as an antidote.

I have sampled both new forms. After exploring one possible compound I was quite relaxed and sleepily inebriated for an hour or so, then within minutes of taking the antidote I was up giving a lecture with no impairment whatsoever.

All that is needed now is funding to test and put them on the market. A few contacts within the alcohol industry suggest they are interested but do not need to engage until this new invention becomes a threat to their sales. This is a similar situation to that of the tobacco companies when e-cigarettes were being developed. They stood back at first but now own many of the companies making the safer alternatives to cigarettes. Likewise, without investing in a new approach to alcohol, we shall not realise the enormous health potential of a safer alternative.