TUNKU ABDUL RAHMAN UNIVERSITY OF MANAGEMENT AND TECHNOLOGY

Centre for Pre-University Studies

FPEC1014 Principles of Economics

Topic : 1 – Basic Economic Ideas

1. What is economics?
Economics is the study of how society uses scarce resources to produce goods and services to
satisfy unlimited human wants.

2. Limited resources / factors of production:

❖ Land – refers to all natural resources that are gifts of nature. E.g. river, forest, mineral, sea,
land.

❖ Labour – refers to human resources or the mental and physical ability of workers to produce
goods and services.

❖ Capital – refers to man-made aids used to produce other goods. E.g. machinery, assembly
plant, robots, buildings, trucks, roads.

❖ Enterprise – refers to the action of an individual that organises the other three factors of
production, involves taking risk to produce goods and services to fulfill human wants.

3. Three basic economic problems:

❖ What and how much to produce?
The problem of scarcity restricts our ability to produce everything we want during a given
period, so the choice of producing more of one good, requires producing less of another
good. This will lead to opportunity cost.

❖ How to produce?
Society has to decide how to combine technology and the scarce resources to produce goods
and services. The production technique could be labour-intensive or capital- intensive method
of production.

❖ For whom to produce?

Society must know how to distribute the produced goods and services. This is usually
determined by income distribution. Those in the higher income group will get more and
better quality goods as compared to the lower income group.

4. Opportunity cost is defined as the next best alternative sacrificed for a chosen alternative.
❖ When we choose one alternative, we must forgo all the other alternatives. The next best
alternative given up is the opportunity cost of what we have chosen.
❖ Scarcity → choices → opportunity cost

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 ❖ Example:
Raymond hopes to be a rock star, and he would need a large amount of income to set up his
band. By doing so, he must forfeit a large amount of income to attend college and the
opportunity cost is the inability to further his studies.

5. Types of goods:
❖ Economic goods

• Can be defined as goods where opportunity cost is involved. There is a price to be paid for
these goods. It has the characteristics of excludable and involves rivalry. They are scarce
in supply.

• Examples: television, clothing, raw materials.

❖ Private goods

• A private good or service has three main characteristics:

(i) excludability
Consumers of private goods can be excluded from consuming the product if they are
not willing or able to pay for it. For example, a ticket to the cinema or a meal in a
restaurant. Another good example is the increasing use of “pay-per-view” as a means
of extracting payment from people wanting to watch exclusive coverage of sporting
events on television or the use of subscription-based services on the internet.
Examples: Astro, HyppTV

(ii) rivalry in consumption

With a private good, one person’s consumption of a product reduces the quantity left
for others to consume – because scarce resources are used up in producing and
supplying the good or service. Example: If you order the last piece of pizza, then that
pizza is no longer available to someone else. Likewise driving your car on a road uses
up road space that is no longer available at that time to another motorist.

(iii) rejectability
Private goods and services can be rejected. If you don’t like the meal on the
college menu, you can use your money to buy something else at somewhere else. You
can also choose not to travel by bus or you can choose instead to travel by taxi.

❖ Free goods

• Can be defined as goods with zero opportunity cost. They are abundant in supply
(unlimited in quantity) and are considered as gifts of nature. There is no price to be paid
for these goods.

• Examples: air, sunlight, rainwater, snow, wind

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❖ Capital goods

• Can be defined as goods that can be used to produce other goods.

• Examples: machinery, factories

❖ Consumption goods

• Goods that are consumed by people and give immediate satisfaction. Consumption goods
can satisfy human wants.

• Examples: clothing, shoes, food, health services

❖ Public goods

• Can be defined as goods and services provided by the government for communal use.
Nobody is prohibited from using these goods and services, regardless whether he is a
taxpayer or not.

• Public goods have the characteristic of:

(i) non-excludability
Nobody is prevented from using the public goods.

(ii) non-rivalry
The consumption by one person will not reduce the availability of the goods to others.
Examples: street lighting, flood control systems, national defence services

❖ Merit goods

• Can be defined as goods and services that are beneficial to consumers.

• Merit goods are goods and services that the government feels that people will under-
consume, and which ought to be subsidized or provided free at the point of use.

• Both the public and private sectors provide merit goods & services.

• Consumption of merit goods is widely believed to generate positive externality effects –

where the social benefit from consumption exceeds the private benefit.

• A merit good is a product that society values and judges that everyone should have
regardless of whether an individual wants them. In this sense, the government is acting
paternally in providing merit goods and services. The government believes that merit
goods are under-consumed as individuals have imperfect information about the benefits
that can be derived from these goods. Examples: health services, education, work training
programmes, public libraries

• The government often provides merit goods “free at the point of use”, financed through
taxation. Examples include primary health care available to people through the National
Health Service and books borrowed from local authority libraries.

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6. Production Possibility Curve (or Production Possibility Frontier)
❖ It shows the various possible combinations of goods and services that the economy can
produce given a limited amount of resources and the most efficient technique of production.

❖ Assumptions made when drawing a production possibility curve:

• The amount of resources in an economy is fixed, but these resources can be transferred
from one use to another.
• The economy produces only two types of goods.
• The economy is at full employment which means the resources are fully and efficiently
utilised.
• The level of technology is assumed to be constant.

❖ Diagram

Good Y (units)

B G

F C

D
0 Good X (units)

Explanation
• A country produces only two goods, good X and good Y.
• Point A on the PPC indicates that the economy would allocate all its resources to provide
good Y only and zero units of good X. At the other extreme, point D indicates that the
economy would allocate all its resources to provide good X only and zero units of good Y.
• Points A, B, C and D indicate that the economy has achieved full employment, hence uses
all the resources available in production.
• The economy can also produce any combination inside the curve, but this would mean that
some resources are unemployed or inefficient method of production is being used. E.g.
point F. The economy could produce more of both goods by moving to a point such as
point C. If the point inside PPC such as point F moves towards the PPC e.g. point C, it is
referred as an increase in economic activities.
• Points outside the PPC such as point G are not attainable with the present production
capacity.

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 • The factors which enable point G to be achieved are:
a) An increase or advancement in technology
b) Increase in labour force
c) Increase in population
d) Increase in resources example raw materials
e) Specialization and division of labour

7. (a) Production possibility curve with increasing opportunity cost

❖ The production possibility curve displays a bowed-out shape due to the increasing
opportunity cost. The opportunity cost increases as production of one output expands.

❖ Table and Diagram

Combination Good X (units) Good Y (units)

A 1 10
B 2 9
C 3 7
D 4 4
E 5 0

Good Y (units)

10 A
9 B

7 C

4 D

0 1 2 3 4 5 Good X (units)

Explanation
The production possibility curve displays a bowed-out shape (meaning the shape is
concave to the origin) due to the increasing opportunity cost. The opportunity cost
increases as production of one good expands. This means that to increase one unit of a
good, the number of units of the other good that needs to be forgone or sacrificed increase
at each combination of production. For example, to increase 1 unit of good X from 1 unit
to 2 units, the economy has to sacrifice 1 unit of good Y (= 10 units - 9 units). To increase
1 more unit of good X from 2 units to 3 units, the economy has to sacrifice 2 units of good
Y (= 9 units - 7 units). This shows that the opportunity cost is increasing.

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7. (b) Production possibility curve with constant opportunity cost
❖ The production possibility curve displays a downwards sloping straight line due to the
constant opportunity cost. The opportunity cost remains the same as production of output
expands.

❖ Table and Diagram

Combination Good X (units) Good Y (units)

A 0 50
B 1 40
C 2 30
D 3 20
E 4 10

Good Y (units)

50 A

40 B

30 C

20 D

10 E

0 1 2 3 4 5 Good X (units)

Explanation
The production possibility curve is a straight line that is downward sloping. This means
that to increase one unit of a good, the number of units of the other good that needs to be
forgone or sacrificed is constant at each combination of production. For example, to
increase 1 unit of good X from 0 to 1 unit, the economy has to sacrifice 10 units of good Y
(= 50 units - 40 units). To increase 1 more unit of good X from 1 unit to 2 units, the
economy has to sacrifice another 10 units of good Y (= 40 units - 30 units). This shows
that the opportunity cost is constant and the production possibility curve displays a
downward sloping straight line.

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8. Economic growth
❖ The outward shift in the PPC is referred as economic growth. The country’s capacity to
produce goods increases. This outward shift permits the economy to produce greater
quantities of output. Technology advances or growth in the resource base enables the PPC to
shift outwards.

❖ Diagram

Good Y (units)

15 B

10 A

PPC PPC1

0 10 18 Good X (units)

Explanation
The production possibility curve shifts outward or to the right from PPC to PPC1 indicating
economic growth. This means that the economy (or country) is now able to produce more
goods and services. At point A, the economy produces 10 units of good X and 10 units of
good Y. With economic growth, the economy is able to produce more of good X and good Y.
This is shown by point B where the economy produces 18 units of good X and 15 units of
good Y.

❖ Factors that may cause the production possibility curve to shift to the right are as follows:

• increase in workforce due to population growth or the import of migrant workers

• increase in the productivity level of the workforce due to specialisation of labour, training
and education

• technological improvements with the use of machines, robots in the production process
which can help boost the productivity level

• the economy has found new resources like oil, coal, iron that can help increase output

• the inflow of foreign investment that brings in new methods of production and better
technology level

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9. Production possibilities of a country could have declined where the PPC shifts inward.
❖ Factors that lead to an economic decline are:
• depletion of natural resources
• natural disaster
• war
• decrease in population
❖ Diagram

Good Y (units)

7 A

5 B

PPC1 PPC

0 5 8 Good X (units)

Explanation

The production possibility curve shifts inward or to the left from PPC to PPC1 indicating
economic decline. This means that the economy (or country) is now able to produce less (or
fewer) goods and services compared to before. At point A, the economy produces 8 units of
good X and 7 units of good Y. With economic decline, the economy is producing fewer of
good X and good Y. This is shown by point B where the economy produces 5 units of good X
and 5 units of good Y.

10. Economic systems

An economic system is a complex network of individuals, organisations and institutions in a
society whose decision determine the ways in which the scarce resources are used to produce
goods and services and the manner in which these outputs are distributed for consumption.
There are three types of economic systems:

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❖ Command economy

• It is also known as a planned economy. Everything is controlled by the government and the
three basic economic problems i.e. what and how much to produce, how to produce and for
whom to produce will be solved by the government.

• Features:
✓ All factors of production are owned by the state or government.
✓ Centralised planning – All economic activities are decided and controlled by the central
planning authority.
✓ Choice – Individuals have little choice (or low consumer sovereignty) as the type of
goods produced is determined by the government.
✓ There are little incentives for enterprise and innovation.
✓ Inefficient allocation of resources – tend to have shortages of certain goods and services
and surplus of others. This represents a waste of resources.
✓ Tendency to exist large bureaucratic structure where there is a need to coordinate and
control the system to ensure that various units perform their assigned tasks. Such huge
structures tend to create problems in communication and coordination.
✓ Income and growth – Failed to match growth performances of the other two economic
systems.

• Examples: North Korea, Cuba

❖ Market economy

• It is also known as the capitalist, laissez-faire economy. There is no government

intervention and all economic activities are carried out by the private sector or individuals.

• Features:
✓ All factors of production are privately owned by individuals, firms and institutions.
✓ Freedom of choice – Individuals have the right to own, control and dispose of their
resources in any way they want. Consumers are free to choose goods and services that
satisfy them. Consumers are provided with a wide range of choice in terms of price and
quality.
✓ Self-interest as the dominating motive – Consumers attempt to maximise satisfaction
while producers attempt to maximise profit.

✓ Consumers indicate to the producers what they desire by the price that they are willing
to pay. The higher the price, the higher level of profit to the producers. Resources are
channeled to produce the goods that individuals demand. In order to maximise profit,
the producers must maximise revenue and minimise cost. The producer may decide to
use either labour-intensive method or capital-intensive method.
✓ Goods will be produced for those consumers who are willing to pay and able to pay.
Usually the quantity of goods in the market is insufficient to meet the demand of all
who are willing to pay. Competition will drive up the price eliminating those who are

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 unable or unwilling to pay. Thus product price will ration out scarce goods to those who
can afford to pay the price.
✓ The economy achieves economic efficiency in allocating resources. Self-interest
encourages the use of resources in line with consumers’ preferences. The producers
produce goods according to the wants of society. There is minimum wastage in terms of
producing goods that are unwanted.
✓ There will be automatic response to change and there is no need for costly and complex
bureaucracies to coordinate plans. The producers will respond to the change in the
demand of the goods and reallocate resources accordingly.
✓ High economic growth can be achieved as the high profit is the reward thus incentive to
increase productivity.
✓ However there will be inequality in income distribution due to the non-intervention by
the government. A wide gap between the poor and the rich exists. The rich who are
normally the producers will get richer while the poor will get poorer.
✓ Problems of negative externalities exist such as pollution.
✓ The economy fails to provide public goods such as street lighting.

❖ Mixed economy

• Both the public sector and private sector work hand in hand to ensure the economic growth
of the country.

• Features:

✓ Resources are partly owned by private individuals and partly by the state or
government.
✓ The main motivation of the private producers is profit while the state attempts to
consider the welfare of the community. The private sector conducts businesses in the
economy and the government encourages the private sector by providing them with
infrastructures such as electricity, water, highways and ports.
✓ The role of public sector is not to compete with the private sector but to complement the
private sector by providing assistance and infrastructures to speed up economic growth.
✓ The government will create a framework of rules to supplement and modify the price
system to achieve high economic growth and to stabilise the economy.

✓ The government will also control the existence of monopolies. A monopolist is a single
seller of a particular good that usually reduces output to keep prices of its goods high. In
this way, the consumer is exploited when needed to pay a high price for the goods and
the government intervenes to regulate the power of monopolies.
✓ There will be the redistribution of income by the government to achieve a more
equitable distribution. The government may impose a progressive tax system where
higher income earners are taxed more than the lower income earners and the poor are
give assistance in the form of subsidies. In this way, the gap between the poor and rich
is narrowed down.

• Examples: Malaysia, Singapore

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