B220 Microeconomics

MI01: Central Economic

Problem & Economic Systems
Lecture Notes
Learning Outcomes
• Explain scarcity and its application to resource allocation
• Identify the four types of factors of production
• Relate the concepts of opportunity costs / production possibilities to
resource allocation within an economy
• Apply the factors contributing to the shifts of production possibilities curve
• Explain the circular flow of economic activity in a closed economy
• Explain how economic systems develop under different circumstances –
The invisible hand & its limit

2
Section A: Is there Enough?

3
Activity 1
Suppose you won $1000 cash prize in a lucky
draw.

What would you buy with this cash prize?

4
The Study of Economics
Limited Unlimited
Resources Wants

Economics 5
Factors of Production
Land Capital
Everything that grows on Physical capital : factories,
land or is found under it. machinery, infrastructure
(roads, buildings)
Example: oil, fish, minerals

Entrepreneurship Labour
The organizing and risk-taking
factor of production.
The human factor
Entrepreneurs organize the other
Example: Workers
factors of production to produce
goods and services
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Activity 2
Identify the types of factors of production shown in Table 1 below.

Table 1
Type of resource Type of Factors of Production

a) Assembly Line Worker

b) Bill Gates
c) Nestle Manufacturing facility
d) Iron ore
e) Marina Coastal Expressway

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Central Economic Problem
Scarcity imposes choices on decision-makers.
Scarcity
Decisions are influenced by :
• Benefits
• Costs

Benefits versus costs

• Opportunity cost

Choices
Basic questions in economics:
What to produce & in what quantities?
Opportunity Cost/ How to produce?
tradeoff For whom to produce?

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Central Economic Problem
Scarcity Choices Opportunity Cost

Trade-offs involved.
Make choices that are
purposeful – try to get the The cost of decision
most satisfaction from measured in terms of
Limited time and limited resources [rational the next best
resources behaviour] alternative forgone 9
Scarcity, Choices and Opportunity Costs
When U.S. companies decided to
Companies make choices to move their production to Asia, they
maximize their profits may need to down size their U.S.
operation, forgoing the US skilled
workforce.

Governments make choices When the government spends on

to maximize social benefits campaigns to encourage people to
(education spending) and minimize stop smoking to reduce social cost, it
social costs (pollution), based on will reduce the funds available for
limited funds from tax education. The opportunity cost is the
funding forgone for education.

Individuals make choices to When an individual spends his bonus

maximize their satisfaction levels for the down payment of a car, he
(or utility) may need to forgo his Europe
holiday. 10
Singapore:
Singapore:Scarcity,
Scarcity,Choices
Choicesand
and
Opportunity
OpportunityCosts
Costs

11
Singapore: Scarcity, Choices and
Opportunity Costs

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Singapore: Scarcity, Choices and
Opportunity Costs

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Activity 3
Match the correct concept (on the left) to the relevant statement
(on the right).

Ming bought a private condominium

Scarcity apartment instead of a cheaper HDB flat

Choice Price of land is expensive in Singapore

Opportunity In order to save money to finance his

Cost condominium, Ming needs to cut back
on luxury holidays
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Section B: What do we Sacrifice?

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The Production Possibility Frontier (PPF)

Click here to watch video Click here to watch video

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The Production Possibility Frontier (PPF)
Garments A curve that shows the maximum combinations of goods
and services that can be produced by an economy in a
Y given time period, given all resources are fully utilized.
Z
Point Y: All production is devoted to producing garments,
no cars are produced.
Point X: No garments are being produced, only cars are
produced.
At point Z, resources are being shared between the
X Cars production of both goods.

What are the The opportunity cost of producing more garments is the
assumptions of number of cars that are NOT produced or forgone.
the PPF?
PPF shows Concepts of Scarcity, Choice and
Opportunity Cost 17
The Production Possibility Frontier (PPF)
Points on PPF (Potential output):
C Optimal utilization of resources
Garments B
A

A movement from a point inside

the PPF (e.g., Point E) to a point D
Points within PPF Points outside PPF:
on the PPF (e.g., Point A) could (Actual output): E Shows scarcity –
be due to better utilization of Resources are Unattainable given
resources as the economy under-utilized in the constant technology/
recovers from a recession. economy resources in the economy
Cars

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 The Production Possibility Frontier (PPF)
Garments Outward Shift of the PPF = Economic Growth

Reasons for outward shift:

• Increase in the QUANTITY of resources such as labour,
land and capital
• Increase in the QUALITY of resources such as through
training and education
• Increase in the level of TECHNOLOGY, results in better
methods of production

Cars Examples:
What could
• Increase in the size of labour force
cause an inward
• Increase in the amount of land available
shift of the PPF?
• Increase in the amount of capital
• Increase in the skills of labour force 19
Case Study: Impact on the Production Possibility Frontier (PPF)

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 The Production Possibility Frontier (PPF):
Increasing Opportunity Cost
Point A to Point B
To produce 1 more garment, 3 cars need to be given up.
Garments C
B
Point B to Point C
1 unit To produce 1 more garment, 8 cars need to be given up.
A
1 unit
Opportunity cost is bigger for movement from B to C compared to
movement from A to B.

The PPF is a concave curve because not all resources used to

produce garments and cars are equally suited at producing both
goods.

As we move towards point C, where fewer cars are being produced, it

is unlikely the workers who usually produce cars will be as productive
as workers who usually produce garments, and vice versa.
8 units 3 units Cars
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Example of Constant Opportunity Cost
Muffins Cupcakes

Muffins
10 0
9 1

10
8 2
-1 unit
7 3
-1 unit
6 4
5 5
5
4 6
3 7

1 2 8

0
1 9
1 5 10
Cupcakes 0 10
+1 +1
unit unit

The economy forgoes the same amount of one good (e.g. muffins) when
producing more of the other (e.g. cupcakes).
Not realistic for entire economy because different resources are better
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suited for the production of different products.
Activity 4
Figure 1 shows the production possibility frontier (PPF) of Country X.

Figure 1 a) What is the opportunity cost of

producing a yard of cloth in moving
along the PPF from Point a to Point b
in Figure 1?
b) If there is high unemployment level in
Country X, use the PPF to explain how
the economy is operating.
c) If Country X is going to reclaim more
land, how will it impact the PPF?

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 Section C:
What…..How…..Whom…..

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Economic Systems

1) The market economy / Pure free market

2) Planned economy / Command economy
3) Mixed economy
 Because of scarcity, each economy must decide on how to answer
the 3 economic questions:
 What to produce and how much to produce ?
 How to produce ?
 For whom to produce ?
 These 3 questions are answered differently depending on the type of
economic system a country adopts
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 Command Mixed Pure Market
Economy Economy Economy
• Decisions made by the • Some resources are • Works on the belief that it
planning authorities owned by individuals, is more efficient for
(usually government some by the government individuals to make
agencies) and not by • Decisions are made by market decisions/choices
individuals/businesses both the market and the • Buyers and sellers
• No market activity allowed government communicate their
– economic decision- • Government intervenes intentions through prices
making process is where market fails • Individuals and businesses
centralized • Four areas of intervention: own resources, goods and
Business sector, services and use them as
household sector, goods they choose
markets and factor • No government
markets intervention – buyers and
sellers make all the
economic decisions –
guided by the Invisible
Hand mechanism

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Response of Economic Systems to 3 Basic Questions
ECONOMIC WHAT TO PRODUCE? HOW TO PRODUCE? FOR WHOM TO PRODUCE?
SYSTEM
COMMAND A central planning authority (or A central planning authority A central planning authority decides
ECONOMY government) decides what decides on the combination of who receives the goods and
goods and services to produce. resources (FOP) that will be used services that are produced.
on producing goods and services

MARKET Firms produce goods and Individual firms decide on the Goods and services are distributed
ECONOMY services that consumers are combination of resources to be to individuals and households who
willing and able to buy for prices used in producing goods and are willing and able to buy them.
that will yield profits for the firms. services, that would maximize the
profit of each firm.

MIXED The government steps in to The government intervenes in the Goods and services are distributed
ECONOMY produce goods and services production of goods and services to individuals and households who
(e.g. public goods such as when the private market is not are willing and able to buy them.
roads, national defence) in areas producing / consuming at social However, government intervention
where there is market failure. optimal levels. will affect the price and output
levels in the market. 27
Economic Systems

 In reality, all countries are mixed economies, with different

degrees of the mix;
 Pure market and pure planned economies are theoretical
concepts

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The Circular Flow Model – A Market Economy

• The figure illustrates how

households and firms
interact in the market
economy.
• Factors of production and
goods and services flow
in one direction (red
arrows).
• Money flows in the
opposite direction (blue
arrows).

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The Circular Flow Model – A Market Economy
Households supply Firms supply goods and
factors of services to the goods
production (labour, markets, which then
land, capital, supply the goods and
entrepreneurship) services to households.
to the factor
markets, which then
supply these FOPs
to the firms.

Firms pay money Households spend on goods

(wages, rents, interest and services in the goods
and profits) to the FOPs, markets. This expenditure is
which is then channeled channeled into the firms as
back to the households. payment receipt.
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 Activity 5
In the past, people may exchange chickens for apples, i.e. barter trade. This is no
longer the case in the modern economy. Figure 2 depicts the circular flow of economic
activities in a modern economy.

Figure 2 For each of the events below, identify if they

are part of the goods & services flow /
Goods & Goods &
expenditure flow / income flow / factors of
Services Goods Market Services production flow, in Figure 2.
Expenditure Expenditure
Event 1: Event 2:
Joan paid for her Hadi sold his house
Consumers/ Households
Producers / Businesses groceries at Cold to a firm that wants
Storage. to build a childcare
centre on it.
Income Income Event 3: Event 4:
Factors of
Factor Markets
Factors of
Raj received his Annie bought a pair
Production Production paycheck yesterday. of sneakers at
Adidas.

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Section D: Auto Pilot Mode

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 Invisible Hand Mechanism by
Adam Smith
Coined by classical economist Adam Smith

What it is
The invisible hand refers to the self-regulating nature of the
marketplace in determining how resources are allocated based on
individuals acting in their own self-interest.

Why it matters
It argues that government intervention in the marketplace is
unnecessary. Instead, changes in demand for resources
automatically result in price adjustments without the need for
regulation.

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Examples of Government Intervention in a Mixed Economy

Source: Parkin (2010) Microeconomics Seventh Edition, International Edition, Pearson Addison-Wesley
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 Concept Map
Central Economic Problem Land Economic Systems

Labour
Factors of
Production Command Mixed Pure
Scarce
Resources vs (scarce Market
Unlimited resources)
Capital
Wants
Circular
Flow Model
Entrepreneurship

Choices Invisible
Hand

Opportunity
Cost

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 Challenge Yourself (Optional)
In the real world economy like Singapore, there are capital goods and consumer goods. The
table below shows the difference between capital and consumer goods.

Capital goods Consumer goods

Any kind of machinery, tools or equipment These are used for immediate consumption,
used to make something else. They are not which include food, clothing, and household
used for immediate consumption e.g. appliances e.g. Clothes
Factory Machinery

Figure 4 shows the production possibility frontier of the Singapore economy.

Figure 4
Illustrate how each of the following will affect the production
Capital goods

possibility frontier:

a) Technological improvement affects different sectors of

Singapore’s economy symmetrically
b) Technological improvement that is specific to capital
goods but not consumer goods

Consumer goods
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 Resources
Recommended Text
1. Parkin, M. (2016). Microeconomics 12th Edition. Pearson.
2. Parkin, M. (2016). Economics 12th Edition. Pearson.
3. Gillespie, A. (2014). Foundations of Economics 3rd Edition. Oxford University Press

Websites/Articles
1. Riley, G. (21 Nov 2014). Production Possibility Frontier. Retrieved 25 Mar 2020, from tutor2u website: http://tutor2u.net/economics/revision-
notes/as-markets-production-possibility-frontier.html
2. Heakal, R. (n.d). Economics Basics: Production Possibility Frontier, Growth, Opportunity Cost. Retrieved 25 Mar 2020, from Investopedia
website: http://www.investopedia.com/university/economics/economics2.asp
3. Free Market v. Command Economies. Retrieved 25 Mar 2020, from S-cool website: http://www.s-cool.co.uk/a-level/economics/free-market-v-
command-economies/revise-it/which-system-is-best
4. Circular flow of income diagram, and market system. Retrieved 25 Mar 2020, from FreeEconHelp.com website:
http://www.freeeconhelp.com/2011/09/circular-flow-of-income-diagram-and.html
5. Singapore Budget 2020: $8.3b to be allocated for economic transformation and growth. Retrieved 25 Mar 2020 from The Straits Times
website: https://www.straitstimes.com/singapore/singapore-budget-2020-83-billion-to-be-allocated-to-enable-economic-transformation-and

Videos
1. Factors of Production (Resources). Retrieved 25 Mar 2020 from Youtube Website: https://www.youtube.com/watch?v=VZD7dTSHmIo
2. Econ 1.1 Production Possibilities Curve. Retrieved 25 Mar 2020 from Youtube website:
https://www.youtube.com/watch?v=O6XL__2CDPU&list=PLD5BC727C84E254E5&index=2
3. Econ 1.2 Shifting the Production Possibilities Curve (PPC). Retrieved 25 Mar 2020 from Youtube website:
https://www.youtube.com/watch?v=FwPiWz1a1Tw&index=3&list=PLD5BC727C84E254E5
4. UniversityNow: Types of Economic Systems. Retrieved 25 Mar 2020 from Youtube website:
https://www.youtube.com/watch?v=5xgwYRX19VU
5. AP Economics Circular Flow Model. Retrieved 25 Mar 2020 from Youtube website: https://www.youtube.com/watch?v=YNfIlfua6L0
6. The Invisible Hand - 60 Second Adventures in Economics (1/6). Retrieved 25 Mar 2020 from Youtube website:
https://www.youtube.com/watch?v=ulyVXa-u4wE
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