Q1. The Learning Activity titled "The Production Possibilities Curve" explains concepts that relate the production possibilities curve to scarcity and opportunity cost. Look at Figure 1.3 and select any two points out of points A-C, D-F, or G-I, on any of the three graphs, and explain the opportunity cost between these two points. Also, explain how this graph relates back to the concept of scarcity. Lastly, provide your own example of a production possibilities curve by selecting two goods or services and explaining how it relates to the concept of scarcity and opportunity cost.

Figure 1.3 Production Possibilities at Three Plants

Plant 1 Plant 2 Plant 3 200 A 100 Slope=0.5 0 50 100 O 50 100 0 50 100 Snowboards per month Pairs of skis per month Table 2.2 Selected Federal Regulatory Agencies and Their Missions Federal Reserve Board Federal Deposit Insurance Corporation Securities and Exchange Commission Commodity Futures Trading Commission Product Markets Department of Iustice, Antitrust Division Federal Communications Commission Federal Maritime Commission Surface Transportation Board Federal Energy Regulatory Commission Health and Safety Occupational Health and Safety Administration FinancialMarkets Regulates banks and other financial institutions Regulates and insures banks and other nancial institutions Regulates and requires full disclosure in the securities (stock) markets Regulates trading in future markets Enforces antitrust laws Regulates broadcasting and telephone industries Regulates international shipping Regulates railroads. trucking, and noncontiguous domestic water transportation Regulates pipelines Regulates health and safety in the workplace Figure 3.23 The Elasticity of Demand When the Demand Curve Is Linear Price More clastic Lew elastic Quantity The elasticity of demand is generally different at different points on a demand curve. In the case of a linear demand curve, - (elasti city of demand) becomes smaller as we move down the demand curve.quantity demanded - 252 - 300 x price Remember that the drug was currently being sold for $0.50 a pill, so: quantity demanded = 252 - 300 x 0.5 = 102 The demand curve also told Ellie that if she increased the price by 10% to $0.55, the quantity demanded would decrease to 87 (252 - 300 x 0.55 = 87). Therefore, the percentage change in quantity is: 47 - 102 -14.7% 102 From this, the market research firm discovered that the elasticity of demand at the current price was: - (elasticity of demand) = _ Zo change in quantity -14.7 = 1.47 To change in price 10 Note. Adapted from "The Revenues of a Firm," by Cooper, 2011, Microeconomics: Theory through applications, Chapter 6, Section 2. Copyright 2010 Flat World Knowledge, IncCalculating the Elasticity of Demand: An Example Using this example: quantity demanded = 100 -5 x price Suppose a firm sets a price of $15 and sells 25 units. What is the elasticity of demand if we think of a change in price from $15 to $14 80? In this case, the change in the price is -0.2, and the change in the quantity is 1. Thus we calculate the elasticity of demand as follows: 1. The percentage change in the quantity is y (4%)- 2. The percentage change in the price is - 0.2 15 75 (approximately -1.3%). 3.-(elasticity of demand) is =3. The interpretation of this elasticity is as follows: when price decreases by 1%, quantity demanded increases by 3%. This is illustrated in Figure 3.22. Figure 3.22 The Elasticity of Demand Price (5) Change in price (negative) Change in quantity 14.80 Demand curve Quantity When the price is decreased from $15.00 to $14.80, sales increase from 25 to 26 units. The percentage change in price is -13%. Th e percentage change in the quantity sold is 4%. So - (elasticity of demand) is 3. One very useful feature of the elasticity of demand is that it does not change when the number of units changes. Suppose that instead of measuring prices in dollars, we measure them in cents. In that case, our demand curve becomes: quantity demanded = 100 - 500 x price. Make sure you understand that this is exactly the same demand curve as before. Here the slope of the demand curve is -500 instead of -5. Looking back at the formula for elasticity, you see that the change in the price is 100 times greater, but the price itself is 100 times greater as well. The percentage change is unaffected, as is elasticity.ELASTIC DEMAND Elastic Demand The own-price elasticity of demand (often simply called the elasticity of demand) measures the response of quantity demanded of a good to a change in the price of that good. As your read, think about the answer to the question: How price sensitive are consumers? Marketing managers understand the law of demand. They know that if they set a higher price, they can expect to sell less output. But this is not enough information for good decision making. Managers need to know whether their customers' demand is very sensitive or relatively insensitive to changes in the price. Put differently, they need to know if the demand curve is steep (a change in price will lead to a small change in output) or flat (a change in price will lead to a big change in output). We measure this sensitivity by the own-price elasticity of demand, which basically means the percentage change in quantity demanded of a good divided by the percentage change in the price of that good. When price increases (the change in the price is positive), quantity decreases (the change in the quantity is negative). The price elasticity of demand is a negative number. It is easy to get confused with negative numbers, so we instead use: -(elasticity of demand) = " change in quantity % change in price which is always a positive number. If -(elasticity of demand) is a large number, then quantity demanded is sensitive to price: increases in price lead to big decreases in demand If -(elasticity of demand) is a small number, then quantity demanded is insensitive to price: increases in price lead to small decreases in demand Throughout the remainder of this section, you will often see - (elasticity of demand). Just remember that this expression always refers to a positive number.Market Power The elasticity of demand is very useful because it is a measure of the market power that a firm possesses. Market power is the extent to which a firm produces a product that consumers want very much and for which few substitutes are available. In some cases, some firms produce a good that consumers want very much-a good in which few substitutes are available. For example, De Beers controls much of the world's market for diamonds, and other firms are not easily able to provide substitutes. Thus the demand for De Beers' diamonds tends to be insensitive to price. We say that De Beers has a lot of market power. By contrast, a fast-food restaurant in a mall food court possesses very little market power: if the Chinese fast-food restaurant were to try to charge significantly higher prices, most of its potential customers would choose to go to the other Chinese restaurant down the aisle or even to eat sushi, pizza, or burritos instead. The Elasticity of Demand for a Linear Demand Curve The elasticity of demand is generally different at different points on the demand curve. In other words, the market power of a firm is not constant: it depends on the price that a firm has chosen to set. To illustrate, remember that we found - (elasticity of demand) = 3 for our demand curve when the price is $15. Suppose we calculate the elasticity for this same demand curve at $4. Thus imagine that that we are originally at the point where the price is $4 and sales are 80 units and then suppose we again decrease the price by 20 cents. Sales will increase by one unit: 1. The percentage change in the quantity is a (1.26%%). 2. The percentage change in the price is- 0.2 1 20 (-5%). 3.-(elasticity of demand) is- =0.25. The elasticity of demand is different because we are at a different point on the demand curve. When -(elasticity of demand) increases, we say that demand is becoming more elastic. When -(elasticity of demand) decreases, we say that demand is becoming less elastic. As we move down a linear demand curve, -(elasticity of demand) becomes smaller, as shown in Figure 3.23.Measuring the Elasticity of Demand In aoos. a major pharmaceutical company was evaluating the performance of one of its most important drugs a medication for treating high blood pressurein a Southeast Asian country. {For reasons of confidenliality, we do not reveal the name of the company or the country; other than simplifying the numbers slightly, the story is true.) Its product was l-mown as one of the best in the market and was being sold for 3415:} per pill. The company had good market share and income in the country. There was one major competing drug in the market that was selling at a higher price and a few less important drugs. In pharmaceutical companies, one individual often leads the team for each major drug that the company sells. In this company. the head of the product team we will call her Elliewas happy with the performance of the drug. Nonetheless. she wondered whether her company could make higher prots by setting a higher or lower price. In many countliesI the prices of pharmaceutical products are heavy regulated. In this particular country, however, pharmaceutical companies were largely free to set whatever price they chose. Together with her team, therefore. Ellie decided to review the pricing strategy for her product. To evaluate the effects of her decisions on revenues, Ellie needs to know about the demand curve facing her firm. In particular, she needs to know whether the ouanlity demanded by buyers is very sensitive to the price that she sets. We now know that the elasticity of demand is a useful measure of this sensitivity. How can managers such as Ellie gather information on the elasticity of demand? At an informal level, people workingin marketing and sales are likely to have some idea of whether their customers are very price sensitive. Marketing and sales personnel if they are any good at their jobs spend time talking to actual and potential customers and should have some idea of how much these customers care about prices. Similarly, these employees should have a good sense of the overall market and the other factors that might affect customers' choices. For example, they will usually know whether there are other firms in the market offering similar products, and, if so, what prices these firms are charging Such knowledge is much better than nothing. but it does not provide very concrete evidence on the demand curve or the elasticity of demand A firm may be able to make use of existing sales data to develop a more concrete measure of the elasticity of demand. For example, a firm might have past sales data that show how much they managed to sell at different prices, or a firm might have sales data from different cities where different prices were charged. Suppose a p1icing manager discovers data for prices and quantities like those in part [a]: of Figure 3.24. IIere. each dot maria an observationfor example. we can see that in one case. when the price was $10G. the quantity demandedwas 23. Figure 3.24 Finding the Demand Curve Price Price 140 140 120 120 100 10D 10 20 Quantity Quantity 10 20 30 40 50 60 10 20 30 40 50 60 (b) (a) This is an example of data that a manager might have obtained for prices and quantities. (b) A line is fit to the data that represe nts a best guess at the underlying demand curve facing a firm. The straight-line demand curves that appear in this competency are a convenient fiction of economists, but no one has actually seen one in captivity. In the real world of business, demand curves-if they are available at all- are only a best guess from a collection of data. Economists and statisticians have developed statistical techniques for these guesses. The underlying idea of these techniques is that they fit a line to the data. (You do not need to worry about the details here.) Part (b) of Figure 3.24 shows an example. It represents our best prediction, based on available data, of how much people will buy at different prices. If a firm does not have access to reliable existing data, a third option is for it to generate its own data. For example, suppose a retailer wanted to know how sensitive customer demand for milk is to changes in the price of milk. It could try setting a different price every week and observe its sales. It could then plot them in a diagram like Figure 3.24 and use techniques like those we just discussed to fit a line. In effect, the store could conduct its own experiment to find out what its demand curve looks like. For a firm that sells over the Internet, this kind of experiment is particularly attractive because it can randomly offer different prices to people coming to its website. Finally, firms can conduct market research either on their own or by hiring a professional market research firm. Market researchers use questionnaires and surveys to try to discover the likely purchasing behavior of consumers. The simplest questionnaire might ask, "How much would you be willing to pay for product x?" Market researchers have found such questions are not very useful because consumers do not answer them very honestly. As a result, research firms use more subtle questions and other more complicated techniques to uncover consumers' willingness to pay for goods and services. Ellie decided that she should conduct market research to help with the pricing decision. She hired a market research firm to ask doctors about how they currently prescribed different high blood pressure medications. Specifically, the doctors were asked what