Question

1. 6 marks (Chapter 16.4 Efficiency in Input Allocation) Chip Labor Auto Capital Chip Captial Auto Labor The Edgeworth Box diagram above refers to input usage in the automobile industry and the computer chip industry. The contract curve is given by 0A0C. All points on this curve correspond to input prices being equivalent across industries. For example, the line segment AC indicates the input price ratio at point B in the two industries. Also, line segment DF indicates the input price ratio at point E in the two industries. The diagram below presents the production possibilities frontier for automobiles and computer chips. Chips Autos The labeled points in the production possibilities frontier diagram correspond to the points A, B, E, and F in the Edgeworth Box diagram above. Which points in the production possibilities frontier diagram correspond to which points in the Edgeworth Box diagram? Why?

Answer 1

The point W corresponds to A

The point X corresponds to B

The point Z correspobds to E

The point Y corresponds to F

The production possibility curve is the derivative of the contract curve.

All the points on the contract curve and the production possibility frontier represents the Pareto efficient allocation.

The points B and E are Pareto efficient, whereas the points A and F are Pareto inefficient.

The slope of the production possibility frontier is the marginal rate of product transformation. At equilibrium the rate of product transformation will be equal to the relative prices