introduction to econ new 2

Production possibilities curve

UNIT 01 PART 02

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What is a PPC or PPF??• The production possibility

frontier (PPF) is a curve depicting all maximum output possibilities for two or more goods given a set of inputs (resources, labor, etc.). The PPF assumes that all inputs are used efficiently.

• Compare 2 variables; goods or services• Trade-offs or opportunity cost involved• All available resources are fully employed• All available technology is fully employed• Productive efficiency: Resources are

employed in the least costly way• Technology and production techniques

remains constant within the time of consideration

Abstractions and Assumptions of a PPC

Determinants of PPC• Stock of resources• Productivity of the resources

Opportunity costs v shape of the PPC

• Increasing opportunity costs– Concave to the origin

• Decreasing opportunity costs– Convex to the origin

• Constant opportunity costs– Straight line curve

• Zero opportunity costs– Parallel curve

Increasing opportunity cost per unit of good B

Increasing Opportunity Cost

Q. Fill in the following table and draw the PPC Good X Good Y Opportunity cost of

Y1000 0900 100750 200550 300300 4000 500

Reasons for increasing opportunity costs

• Resources are not homogenous• Techniques of production used to

produce different goods are different• The differences of efficiencies among

industries• A resource that is more appropriate

to produce a particular good is not so appropriate to produce another good

Zero opportunity cost per unit of good B

Q. Give example for situations where opportunity cost becomes zero• Using resources which are

unlimitedly available• When there are no alternative uses

for the resource• When resources are not fully utilized

Constant opportunity cost per unit of good B

Here in this case the sacrificed units equals to the units produced (new)

Decreasing opportunity cost per unit of good B

Impossible; not

supported by

economic theory

Drawing a PPCGood X

Good Y0

Full employmentGood X

Good Y0

BA

C

D

Any point on the curve shows full employment of resources

Full efficiencyGood X

Good Y0

BA

C

D

Any point on the curve shows full efficiency of resources

Full utilization of resourcesGood X

Good Y0

BA

C

D

Any point on the curve shows full utilization of resources

Achievable regionGood X

Good Y0

Any point within the curve/inside the boundary is achievable by the society

Unachievable regionGood X

Good Y0

Any point outside the boundary is unachievable by the society

Scarcity Good X

Good Y0

A Due to scarcity of resources point A can not be achieved

Choice Good X

Good Y0

A B

C

D

E

A society can choose to produce any product combination represented by letters A,B,C,D or E

Alternative options Good X

Good Y0

A B

C

D

E

A society can choose to produce any product combination represented by letters A,B,C,D or E

Unemployment of resourcesGood X

Good Y0

A

Point A shows unemployment of resources. Here in this case resources are either wasted or not used

Under-utilization of resources

Good X

Good Y0

A

Point A shows under utilization of resources. Here in this case resources are either wasted or not used

Idle resourcesGood X

Good Y0

A

Point A shows existence of idling resources. In this case resources are not managed well

Recession Good X

Good Y0

A

B

Recession is a short term downfall of the economy and it can be shown by a point shift from A to B

Depression Good X

Good Y0

A

B

Depression is a long term downfall of the economy and it can be shown by a point shift from A to B

Depression Good X

Good Y0

A

Depression is a long term downfall of the economy and it can be shown by the point A

Depression Good X

Good Y0

Depression is a long term downfall of the economy and it can be shown by a downward shift

Movement of a point without scarification- no

opp. costGood X

Good Y0

A

B

Movement of a point without scarification- no

opp. costGood X

Good Y0

A

B

Movement of a point without scarification- no

opp. costGood X

Good Y0

A

B

Movement of a point without scarification- no

opp. costGood X

Good Y0

A

B

Consumption of a goods bundle lying outside the curve

Cars

Tea 0

A

B

EXPORT

IMPORT

International trade

Cars

Tea 0

A

B

EXPORT

IMPORT

Shifts in PPC• A PPC may shift rightward or leftward

due to– Change in factors of production– Change in factors of productivityEither– Quality wise OR– Quantity wise

Increase in labor productivity

Good X

Good Y0

Addition to labor forceGood X

Good Y0

Redefinition of the working ageGood X

Good Y0

Technological advancements

Good X

Good Y0

Employment training and development

Good X

Good Y0

Increase in educational levelGood X

Good Y0

Use of new management techniques

Good X

Good Y0

Specialization of employeesGood X

Good Y0

Division of labor leading to specialization

Good X

Good Y0

Foreign investments coming into the country

Good X

Good Y0

Promotion of peaceGood X

Good Y0

Increase in labor productivity

Good X

Good Y0

Discovering new lands suitable for cultivation

Good X

Good Y0

Cultivation done in new lands discovered recently

Good X

Good Y0

Discovering new oil wells in Jaffna

Good X

Good Y0

Extraction of oil from wells that were discovered recently in Jaffna

Good X

Good Y0

Giving a fertilizer subsidy to farmersCars

cultivation

0

Biased development in agricultural sector

Cars

cultivation

0

Introduction of new technology to produce cars

Cars

cultivation

0

Net out migration of skilled employees

Good X

Good Y0

Use of outdated technologyGood X

Good Y0

Civil warGood X

Good Y0

Natural disasterGood X

Good Y0

Racial discriminationGood X

Good Y0

Trade protectionismGood X

Good Y0

Imposing trade restrictionsGood X

Good Y0

Economic growthGood X

Good Y0

Economic growth leading to unemployment

Cars

cultivation

0

Economic declineGood X

Good Y0

Increase in GDP of the countryGood X

Good Y0

Present consumption v future production-1

Consumer goods

Investment goods

0

Present consumption v future production-2

Consumer goods

Investment goods

0

Present consumption v future production

Consumer goods

Investment goods

0

Present investment v future production-1

Consumer goods

Investment goods

0

Present investment v future production-2

Consumer goods

Investment goods

0

Present investment v future production-

Consumer goods

Investment goods

0

Economic Systems

What is an economic system????????

• An economic system is the way in which an economy is formed based on their characteristics, features, culture and traditions etc.

Characteristics of an economic system

• Resource ownership by either feudal lord, private sector or public sector

• Existence of a governing body• The target market i.e. either poor,

rich or community• Driving motive i.e. profit or social

welfare

What are the reasons for the existence of variety of economic systems?

• Variety in resource allocation• Difference in ownership of resources• Differences in culture• Difference in governing body i.e.

state or private sector• Difference in traditions

What are the basic types of economic systems?

• Command/planned/socialistic economy

• Market economy• Mixed economy• Transitional economy

Different types of entities that can be seen in an economic system

• Households• Business firms• Government• Labour organizations• Non governmental organizations• Markets

Functions of an economic system

• Determining what commodities are produced and in what quantities.

• Selection of the production technique.

• Taking the distribution decisions.

Criteria that can be used to evaluate an economic

system• Full employment• Economic efficiency• Economic growth• Price stability• External stability• Quality of government• Economic freedom• Fair distribution of income & wealth

Traditional economy• Based on traditions and customs• Was governed by a feudal lord• No formal structure • Barter was the main form of trade• The resources, lands were owned by

the feudal lord

Command/planned/socialistic economy

• State ownership of resources/factors of production except labour

• Less disparity of income• Decisions are taken by a centrally planned

authority• All activities are controlled by the government• Less/no competition• Based on social welfare• No consumer sovereignty

What is consumer sovereignty???

• Consumer sovereignty refers the ability of consumers to influence decisions taken by governing party.

• Consumer sovereignty exist in a market economy where demand curve denotes the choices or preferences of consumers

Reasons for the failure of socialistic economy

• Lack of a planning mechanism• Inefficiencies in the public sector• Political interference• Lack of motivation• Tall structures• Bribery and corruption• High administrative costs

Market economy• Private ownership of resources,

factors of production• Existence of a price mechanism• Consumer sovereignty• Competition between both

consumers and producers• Based on self interests• Entrepreneurs are based on the

motive of profits

Price mechanism• The system in which the basic

economic problems are solved with the use of price can be simply known as price mechanism

• There are three functions of price in a market economy.

• They are– Signaling function-gives information– Incentive function-gives a motive– Rationing function-allocation idea

Functions of profit• Profit encourages innovations• Resource allocation is done

effectively• Profit is a market signal• Higher profits increases the MPS

Invisible hand theory• In a market economy the free market forces

decides the prices and quantities of goods and services to be produced

• The buyers and producers decisions are affected by their self interests– Consumers; maximum utility– Producers; maximum profits

• These producers and consumers decisions are contradicting to each other and they are controlled by the price

• Thus price is called an invisible hand in a market economy.

Mixed economyCommand + market • Features of both market & command

could be seen

Transitional economy• A transition economy or transitional

economy is an economy which is changing from a centrally planned economy to a market economy.

Command economy

Market economy

Examples Transitional Command Market Mixed RussiaChinaUkrainePolandHungaryRomaniaVietnamUzbekistanKazakhstanCzech Rep

CubaNorth KoreaChinaSoviet Union

CanadaUKGermanyNetherlandsUSA

Sri LankaIndiaPakistan

RASHAIN PERERArashainperera@gmail.com0770593752

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