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Levels of answering questions

Level 1 – Knowledge (K)

Level 2 – Knowledge (K)

Application (A):- Examples, Quotes, Diagrams, Analysis

Level 3 – Knowledge (K)

Analysis (A)

Application (A)

Level 4 – Knowledge (K)

Analysis (A)

Application (A)

Evaluation (E) :- Application of the following words is required when evaluating

issues: However, On the other hand, But, short run and long run,

this depends on, the magnitude, Significant, Extent.

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 The nature of economics

Economics is a social science, which investigates what, how, why and for whom goods and services are produced.
It is therefore the study of human behavior as a relationship between unlimited human wants and scarce (limited)
resources which have alternative uses.

Economic problems

This is a problem that arises from application of scarce resources to meet unlimited human wants. Productive
resources that we have in the economy are so limited that they cannot meet ever increasing human wants. There
is therefore a need to apply these resources more efficiently so that the society can obtain maximum benefits out
of it.

Economics is meant to help us to choose between the competing demands placed on the non-renewable resources
that we have

Scarcity

This refers to resources that are not abundantly available. These resources can equally be used to produce many
goods/services, therefore they have alternative uses

Choice

The resources available to satisfy human wants are at any time limited in supply. As most people cannot have all
the goods and services they want, they have to make choices i.e. they have to choose what they want to have from
the limited resources and what they will have to forego

Opportunity cost

Opportunity cost is the cost in terms of the best alternative foregone. An opportunity cost will usually arise
whenever an economic agent makes a decision about the best way to allocate scarce resources.

Economics decision about resource allocation inevitably requires a sacrifice to be made. The opportunity cost of
a decision quantifies the sacrifice and considers other possible uses of scarce resources.

PRODUCTION POSSIBILITY FRONTIER/CURVE (PPF/PPC)

The PPF shows the maximum output of any two given products that can be produced in an economy at any given
moment when its resources are fully and efficiently employed. If an economy is fully utilizing its resources, then
it will be producing on the PPF. Scarcity, Choice and Opportunity cost can be examined by considering what a
country can produce with its existing resources of land, labour, capital and technical knowledge.

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The PPF can therefore be used to illustrate the concept of opportunity cost in terms of scarce resources and
unlimited human wants.

In the diagram below, the production of 13 more capital goods (32 – 19) incurs an opportunity cost of 6 consumer
goods (32 – 26), i.e. we have had to give up consumer goods production in order to produce more capital goods
because of our limited resources

PPF can be used to demonstrate the concept of efficiency. Any point on the PPF is a productive efficient point –
we’re using the factors of production ( Economic resources, including:- Land, Labour, Capital and Enterprice) to
their maximum potential

Any point inside the PPF (as shown in diangram below) is inefficient – some of the factors of production are
unemployed or underemployed)

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In the diagram above, when the economy is producing at point V, it is productively inefficient because it could
produce more of both products by using the exisisting resources efficiently. If the economy is stuck at point V,
we should look into ways to expanding our output from V to B, which is the PPF. e.g. if the problem is that of un
trained labour, we can engage in imparting skills by training them so that they can take up particular jobs. This
however, could not be possible in the short term, but in the long run the economy will find itself operating on
PPF.

Outward shift in PPF

Once on the PPF, an economy can only produce more of both products by shifting the PPF outwards i.e. increasing
the amount of both proucts that can be produced with the economy’s resources. This is what happens overtime
when an economy grows. Economic growth enables more goods and services to become available to consumers

In the diagram below, there is an improvement in technology which shift the PPF outwards. As a result of this,
output possibilities have increased and we can conclude (priovided the good yields positive satisfaction to
consumers) that there is an improvement in economic welfare. There is an increase in both capital goods and
consumer goods

Causes of an outward shift

An outwardshift of the frontier could be due to:

a) More training of employees enabling them to be more productive

b) Greater investment in capital goods such as machines and equipment – in the short run, this would mean
that resource would have to be shifted from consumer goods towards capital goods and in the long run,
greater investment would enable the economy to produce more products for consumption.
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 c) An increase in the population size e.g. through immigration.
d) Improvement in technology, providing better ways of doing things e.g. research and development
e) Research and development leading to discovery of new resources.

Inward shift in PPF

The PPF can also shift inwards to the left if the economy’s production decline. This could occur due to occurrence
of:

a) Natural disasters like earthquakes, floods etc

b) Wars
c) Insufficient investment spending on replacement of worn out capital goods

The figure below shows a shift of PPF inwards to the left from XX to YY.

A change in the slope of the PPF

If there is a change in the quantity or quality of resources which are specific to the production of one type of
product, the slope of the curve will change e.g. an invention may improve production techniques in production of
notebook computers and this will increase the potential output of Notebook computers without sacrificing
resources for the production of other goods. The PPF will change its slope as shown in the figure below.

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 THE SHAPE OF PRODUCTION POSSIBILITY FRONTIER.

a) When there is increasing opportunity cost

Opportunity cost can be thought of in terms of how decisions to increase the production of an extra
(marginal unit) of one good leads to a decrease in the production of another good. According to economic
theory, successive increase in the production of one good will lead to an increasing sacrifice in terms of a
reduction in the other goods.

For example, as an economy tries to increase the production of good X, such as cameras, it must
sacrifice more of the other good Y, such as mobile phones.
This explains why the PPF is concave to the origin, meaning it is bowed outwards. For example, if an
economy initially produces at A, with 8m phones and 10m cameras (to 20m), and then increases output
of cameras by 10m, it must sacrifice 1m phones, and it moves to point B. If it now wishes to increase

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 output of cameras by a further 10m (to 30m) it must sacrifice 4m phones, rather than 1m, and it moves to
point C; hence, opportunity cost increases the more a good is produced.
This shape reflects the reality of resource limitations and specialization. Resources are often not
perfectly suited for both goods. As you shift resources from one good to another, some resources become
less effective, leading to a steeper sacrifice of the first good for each additional unit of the second.
b) Constant opportunity cost
In previous diagrams we have seen that as more of one good is produced, the opportunity cost rises.
The curve are therefore concave to the origin of the graph i.e. they are bowed outwards. However there is
the chance that if two products use similar methods of production, there may be a constant opportunity
cost. In this case, the PPF will be a straight line as shown below

Here resources are able to switch easily from producing computers to producing leather jackets. For
example, moving from point A to point B, we are getting 1 leather jacket, and giving up 2 computers, this
means that the opportunity cost of 1 leather jacket is 2 computers (2/1). Likewise, if we move from point
B to point A, we are giving up 1 leather jacket, and getting 2 more computers, so the opportunity cost of
2 computers is 0.5 leather jackets (1/2). Note that the two opportunity costs are inverses of each other.
c) When there is a decreasing opportunity cost
If a decreasing opportunity cost is experienced, the PPF will be bowed inwards (convex to the origin
of the graph) as shown in the diagram below

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The opportunity cost of increasing quantity of computers produced falls as the quantity of computers produced
rises. The concept of a convex PPC exists, but it's not a commonly used model in economics because it doesn't
reflect the typical relationship between production choices and opportunity cost.

Economics statements

Economics is concerned with two types of investigation; positive economics and normative economics.

1. Positive economics

This is the scientific or objective study of the subject. It is concerned with finding out how economics and
markets actually work. Positive economics therefore deals with positive statements.

Positive statements

These are statements which can be supported or refuted by evidence. They deal only with facts and their
accuracy can be tested by appealing to the facts. They can be proven to be true or false. If a disagreement
arises over a positive statement, it can be settled by looking at the facts an seeing whether or not they support
the statements.

Examples of positive statements:

a) Inflation rate in Kenya is 14%

b) Economic growth has declined
c) The service sector will grow by 30% in size over the next five years

2. Normative statements
This is the study and presentation of policy prescription involving value judgements about the ways in
which scarce resources are allocated. Normative economics therefore deals with normative statements.

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Normative statements
These are statements which cannot be supported or refuted because there are value judgements. Notmative
statements therefore reflect people’s opinion or moral attitude and cannot be suppoted or refuted by
referring to any data or facts. They are expressions of what some individuals think ought to be done, hence
they express an opinion. Normative statements contain words like; ought, good, fair, would etc.
Examples of normative statements:
a) Britain should join the single currency market
b) More aids should be givent to developed countries
c) It is a good idea to attend classes.

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