CHAPTER 2

Basic concepts
and Problems of
Economics

BEEB 1013: PRINCIPLE OF ECONOMICS,

SEM A171, GROUP Q
ROSLINA KAMARUDDIN
INTHISLECTURE
 The Production Possibilities
Frontier (PPF)
 Increasing and Constant
Opportunity Costs
 Economic Concepts of PPF
 Shift of PPF

CH 2 • 2
 PRODUCTION POSSIBILITIES FRONTIER

Represents the possible

combinations of two
goods that can be
produced in a certain
period of time under the
conditions of a given state
of technology and fully
employed resources.

CH 2 • 3
 PRODUCTION POSSIBILITIES FRONTIER
CONSTANT OPPORTUNITY COSTS

 A straight-line PPF indicates

that the opportunity cost of
producing additional units of
output is fixed.
 A = 4 books & 0 shirt
 B = 3 books & 1 shirt
 What does the economy have
to forfeit (in terms of books) to
get 1 shirt?

CH 2 • 4
PRODUCTION POSSIBILITIES FRONTIER
INCREASING OPPORTUNITY COSTS

 The economy can

produce any of the
five combinations of
cell phones and
coffee makers
 The production
possibilities frontier is
bowed outward
because the
opportunity cost of
producing coffee
makers increases as
more coffee makers
are produced.

CH 2 • 5
 LAW OF INCREASING OPPORTUNITY
COSTS

As more of a
good is produced,
the
opportunity costs
of producing that
good increase

CH 2 • 6
INCREASING OPPORTUNITY COSTS

CH 2 • 7
PRODUCTION POSSIBILITY FRONTIER
FRAMEWORK FOR UNDERSTANDING

CH 2 • 8
 PRODUCTIVE EFFICIENCY AND
INEFFICIENCY
Productive Efficiency
The condition where the maximum output is produced
with given resources and technology

Productive Inefficiency
The condition where less than the maximum output is
produced with given resources and technology.
Productive inefficiency implies that more of one
good can be produced without any less of another
good being produced.

CH 2 • 9
 UNEMPLOYED VS. EMPLOYED
RESOURCES
● When the economy exhibits productive
inefficiency, it is not producing the maximum output
with the available resources and technology. One
reason may be that the economy is not using all of its
resources; that is some resources are unemployed.

● When the economy exhibits productive efficiency it

is producing the maximum output with the available
resources and technology. That is its resources are
fully employed.

CH 2 • 10
 TECHNOLOGY

► Technology is the body of

skills and knowledge
involved in the use of
resources in production
► An advance in
technology commonly
refers to the ability to
produce more output
with a fixed amount of
resources or the ability to
produce the same output
with fewer resources.
CH 2 • 11
ATTAINABLE AND UNATTAINABLE
REGIONS AND PRODUCTIVE
EFFICIENCY

CH 2 • 12
THE PPF AND VARIOUS ECONOMIC
CONCEPTS
► (1) Scarcity is illustrated by
the frontier itself. Implicit in
the concept of scarcity is
the idea that we can have
some things but not all
things. The PPF separates
an attainable region from
an unattainable region.
► (2) Choice is represented
by our having to decide
among the many
attainable combinations of
the two goods. For
example, will we choose
the combination of goods
represented by point A or
by point B?
CH 2 • 13
THE PPF AND VARIOUS ECONOMIC
CONCEPTS
(3) Opportunity cost is most
easily seen as movement from
one point to another, such as
movement from point A to point
B. More cars are available at
point B than at point A, but fewer
television sets are available. In
short, the opportunity cost of
more cars is fewer television sets.

(4) Productive efficiency is

represented by the points on the
PPF (such as AE), while
productive inefficiency is
represented by any point below
the PPF (such as F ).
THE PPF AND VARIOUS ECONOMIC
CONCEPTS III
► (5) Unemployment (in
terms of resources being
unemployed) exists at any
productive inefficient
point (such as F ),
whereas resources are
fully employed at any
productive efficient point
(such as AE).

CH 2 • 15
 ECONOMIC GROWTH WITHIN A PPF
FRAMEWORK

► An increase in resources
or an advance in
technology can increase
the production
capabilities of an
economy, leading to
economic growth and
shift outward in the
production possibilities
frontier.

CH 2 • 16
 ECONOMIC GROWTH WITHIN A PPF
FRAMEWORK

► If the advance in
technology leads to
the greater
production of only
one good (such as
civilian goods in our
exhibit), then the PPF
shifts outward, as
shown in (b).

CH 2 • 17
 1. What does a straight-line
production possibilities
frontier (PPF) represent?
SELFTEST
What does a bowed-
outward PPF represent?
A straight-line PPF represents constant opportunity costs
between two goods. For example, for every unit of X
produced, one unit of Y is forfeited. A bowed-outward
PPF represents increasing opportunity costs. For
example, we may have to forfeit one unit of X to
produce the eleventh unit of Y, but we have to forfeit
two units of X to produce the one hundredth unit of Y.

CH 2 • 18
 2. What does the law of
increasing costs have to do
with a bowed-outward PPF?
SELFTEST

A bowed-outward PPF is
representative of increasing costs. In
short, the PPF would not be bowed
outward if increasing costs did not
exist.

CH 2 • 19
 3. A politician says, “If you elect me, we
can get more of everything we
want.” Under what condition(s) is
the politician telling the truth?
SELFTEST

The first condition is that the economy is

currently operating below its PPF. It is
possible to move from a point below the
PPF to a point on the PPF and get more of
all goods. The second condition is that the
economy’s PPF shifts outward.

CH 2 • 20
The Basic Economic
Questions

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 The 3 Questions

1. What goods and services will be produced?

2. How will the goods and services be produced?

3. Who will get the goods and services?

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 1) What will be produced?
The answer to the first question is that we let the supply and
demand of the market determine what and how much to
produce. Goods that consumers are both willing and able to
buy, and producers are willing and able to make, get made in
the amount that both working together see fit.

‘You may be willing and able to go to the moon, but no

supplier is willing and able to make that available at this time
(although it seems we are getting closer)’

Note consumers “vote” for goods to be made with their dollars

and the goods are likely to be made if firms can make profit.

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2) How will the goods and services be
produced?
Producers will use the least cost combination of inputs to
produce a given level of output. The reason for this is twofold.
First, by using the least cost methods more profit will be
earned by the producer. Producers certainly like to make
profit.
But, the second reason is that if a producer does not use least
cost methods of production, when other producers do, the
high cost producer may not be able to compete with the
other low cost producers and will eventually go out of
business.

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 Resource use
Say there are three ways of making a good from a technical
point of view. Here we list the number of units of each resource
needed to make a good:

Resource technique 1 technique 2 technique 3

Land 4 2 1
Labor 1 3 4
Capital 1 1 2
Entrepreneurial 1 1 1
ability

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 Resource use
Next I show what each resource costs per unit and we can then
see how much it costs to make the units under each technique.
For now, let’s just say we look to the market to find what it costs
to get each unit of each resource. Here technique 2 would be
used!

Resource technique 1 technique 2 technique 3

Land $2 4 ($8) 2 ($4) 1 ($2)
Labor $1 1 ($1) 3 ($3) 4 ($4)
Capital $3 1 ($3) 1 ($3) 2 ($6)
Entrepreneurial $3 1 ($3) 1 ($3) 1 ($3)
ability
Total Cost $15 $13 $15

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 3) Who will get the goods and
services?

Those who are willing and able to pay for the items made.
We become able to pay by giving up something that is
valuable to us - labor or other assets.

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 Economic System

 An organized way in which a state or nation allocates its

resources and distributes goods and services in the
national community.
 The system consist of production, distribution and
consumption.
 Composed of people, institutions and their relationships.
Types of economic system
 Capitalism (Market Economy)

 Socialism (Planned economy)

 Mixed (Capitalism + Socialism)

 Capitalism
 An economic system in which the means of production are
privately owned and operated for profit, usually in competitive
markets.
 Under this system, the means for producing and distributing
goods (the land, factories, technology, transport system etc)
are owned by a small minority of people (capitalist class).
 Adam Smith called “the obvious and simple system of natural
liberty” (Book: Wealth of Nations).
“Subject to certain restrictions, individuals
(alone or with others) are free to decide where
to invest, what to produce or sell, and what
prices to charge. There is no natural limit to the
range of their efforts in terms of assets, sales,
and profits; or the number of customers,
employees, and investors; or whether they
operate in local, regional, national, or
international markets”
Major limitations/ Criticism:
• Downfall of work ethics
• Free Market + Self Interest
• Accumulation of wealth
• Encourages inequality in a society
• Business lobbying with government
• Monopolistic tendency
• Human resource exploitation
• Results in great disparities between
income of people owning the capital
resources and others
Socialism
 SOCIALISM

 An economic system in which property is held in common and

not individually, and relationships are governed by a political
hierarchy.
 However common ownership doesn't mean decisions are
made collectively. Instead, individuals in positions of authority
make decisions in the name of the collective group.
 Socialists argue that socialism would allow for wealth to be
distributed based on how much one contributes to society, as
opposed to how much capital one holds.
 A primary goal of socialism is social equality and a distribution
of Wealth based on one’s contribution to society and an
economic arrangement that would serve the interests of
society as a whole.
Features of Socialism

Social Ownership of means of production

Existence of public sector

Decisive role of Economic Planning

Production guided by Social Benefits

Abolition of exploitation of labour

Benefits of Socialism

Better salaries

Stable Environment

Eliminates poverty

Better Products

Fulfills survival need

Opportunity for citizens to explore non-

economically-productive pursuits
Criticism of Socialism

Distorted price signals

Suppression of economic democracy

Slow Technological advancements

Minimize self management

Reduced incentives
BASIS OF DIFFERENCE CAPITALIST ECONOMY SOCIALIST ECONOMY
Resources Ownership Privately owned State owned

Foundation belief competition brings out the best in cooperation is the best way
people for people to coexist
Earning of wealth everyone works for his own wealth everyone works for wealth
which is distributed equally to
everyone
Market Scenario Level playing field Protection to PSUs, Private
enterprises are permitted in
few businesses only
Govt. interference Only in situations where laws have Fully involved
been broken
Employees motivation Highly motivated on account of Rarely motivated as
proportional benefits performance is not rewarded
Merit Perception of better economic Equal distribution of income
growth because of competition results in welfare of all
Demerit Few individuals/groups attain Hard work is not rewarded,
powers, rest are exploited lazy employees also enjoy
equal level of benefits
 Mixed Economy

 Any economy in which private corporate

enterprises and public sector enterprises
exist side-by-side, and decisions taken
through market mechanism are
supplemented by some form of partial
planning, is to be described as a mixed
economy.

 This system overcomes the disadvantages

of both the market and planned
economic systems.
 Provides a clear demarcation of the boundaries of public
sector and private sector so that the core sector and
strategic sectors are invariably in the public sector.

 The government intervenes to prevent undue concentration

of economic power, and monopolistic and restrictive trade
practices

 The rights of the individual are respected and protected

subject only to the requirements of public law and order
and morality
 Features and Advantages of Mixed
Economy

Features of Mixed Economy Advantages of Mixed Economy

• Resources are owned both • Producers and consumer have

by the government as well as sovereignty to choose what to
produce and what to consume
private individuals. i.e. co- but production and consumption
existence of both public of harmful goods and services may
sector and private sector. be stopped by the government.
• Market forces prevail but are • As compared to Market economy,
closely monitored by the a mixed economy may have less
income inequality due to the role
government. played by the government.
• Monopolies may be existing • A mixed economy represents an
but under close supervision of achievable balance between
the government. individual initiative and social
goals.

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