principles of economics unit 1

8/12/2019 Principles of Economics Unit 1

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CHAPTER 1-----------INTRODUCTION TO ECONOMICS & ECONOMIC SYSTEMS

DEFINITIONS OF ECONOMICS

The word Economics originates from the Greek work Oikonomikos which can be divided into two parts:

(a) Oikos, which means Home, and(b) Nomos, which means Management.

We have now formed an idea about the meaning of Economics. This at once leads to a general definition ofEconomics. Economics is the social science that studies economic activities. This definition is, however,too broad. It does not specify the exact manner in which the economic activities are to be studied.Economic activities essentially mean production, exchange and consumption of goods and services.

However, with the progress of civilisation, the complexity of the production, exchange and consumptionprocesses in society have increased manifold. Economists at different times have emphasised different

aspects of economic activities, and have arrived at different definitions of Economics. We shall now discusssome of these definitions in detail.

These definitions can be classified into four groups:

1. Wealth definitions,2. Material welfare definitions,3. Scarcity definitions, and4. Growth-centered definitions.

Adam Smiths Definition

Adam Smith considered being the founding father of modern Economics, defined Economics as the studyof the nature and causes of nations wealth or simply as the study of wealth. The central point in Smiths

definition is wealth creation. Implicitly, Smith identifiedwealth with welfare. He assumed that, the wealthiera nation becomes the happier are its citizens. Thus, it is important to find out, how a nation can be wealthy.Economics is thesubject that tells us how to make a nation wealthy. Adam Smiths definition is a wealth-centreddefinition of Economics.

Main Characteristics of Wealth Definitions

1. Exaggerated emphasis on wealth: These wealth centered definitions gave too much importance to thecreation of wealth in an economy. The classical economists like Adam Smith, J.S. Mill, J.B. Say, and othersbelieved that economic prosperity of any nation depends only on the accumulation of wealth.

2. Inquiry into the creation of wealth: These definitions show that Economics also deals with an inquiryinto the causes behind the creation of wealth. For example, wealth of a nation may be increased throughraising the level of production and export.


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3. A study on the nature of wealth: These definitions have indicated that wealth of a nation includes onlymaterial goods (e.g., different manufactured items). Non-material goods were not included. Hence, non-material goods like services of teachers, doctors, engineers,etc., are not considered as wealth.

Alfred Marshalls Definition

Alfred Marshall also stressed the importance of wealth. But he also emphasised the role of the individual inthe creation and the use of wealth. He wrote: Economics is a study of man inthe ordinary business oflife. It enquires how he gets his income and how he uses it. Thus, it is on the one side, the study of

wealth and on the other and more important side, a part of thestudy of man. Marshall, therefore,stressed the supreme importance of man in the economic system. Marshalls definition is considered to bematerial-welfare centred definition of Economics.

Features of Material Welfare Definitions

The main features of material welfare-centred definitions are as follows:

1. Study of material requisites of well-being: These definitions indicate that Economics studies only thematerial aspects of well-being. Thus, these definitions emphasise the materialistic aspects of economicwelfare.

2. Concentrates on the ordinary business of life: These definitions show thatEconomics deals with the study of man in the ordinary business of life. Thus, Economics enquires how anindividual gets his income and how he uses it.

3. A stress on the role of man: These definitions stressed on the role of man in the creation of wealth orincome.

Lionel Robbins Definition

The next important definition of Economics was due to Prof. Lionel Robbins. In his bookEssays on the Nature and Significance of the Economic Science, published in 1932, Robbins gave adefinition which has become one of the most popular definitions of Economics. According toRobbins, Economics is a science which studies human behaviour as a relationship between ends

and scarce means which have alternative uses. A long line of economists after Robbins, includingScitovsky and Cassel agreed with this definition and carried on their analysis inline with this definition. It isa scarcity-based definition of Economics.

Main Features of Scarcity Definition

The principal features of scarcity definitions are as follows:

1. Human wants are unlimited: The scarcity definition of Economics states that human wants areunlimited. If one want is satisfied, another want crops up. Thus, different wants appear one after another.

2. Limited means to satisfy human wants: Though wants are unlimited, yet the means


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for satisfying these wants are limited. The resources needed to satisfy these wants are limited.For example, the money income (per month) required for the satisfaction of wants of an individual is limited.Any resource is considered as scarce if its supply is less than its demand.

3. Alternative uses of scarce resources: Same resource can be devoted to alternative lines of

production. Thus, same resource can be used for the satisfaction of different types of human wants. Forexample, a piece of land can be used for either cultivation, or building a dwelling place or building a factoryshed, etc.

4. Efficient use of scarce resources: Since wants are unlimited, so these wants are to be ranked in orderof priorities. On the basis of such priorities, the scarce resources are to be used in an efficient manner forthe satisfaction of these wants.

5. Need for choice and optimisation: Since human wants are unlimited, so one has to choose betweenthe most urgent and less urgent wants. Hence, Economics is also called a science o f choice. So, scarceresources are to be used for the maximum satisfaction ( i.e.,optimisation) of the most urgent human wants.

Modern Growth-Oriented Definition of Samuelson

In relatively recent times, more comprehensive definitions of Economics have been offered.Thus, Professor Samuelson writes, Economics is the study of how people and society end up

choosing, with or without the use of money, to employ scarce productive resources that could havealternative uses to produce various commodities over time and distributing them for consumption,now or in the future, among various persons or groups in society. It analyses costs and benefits of

improving patterns of resource allocation.A large number of moderneconomists subscribe to thisbroad definition of Economics.

Features of the Modern Growth-Oriented Definition

1. Growth-orientation: Economic growth is measured by the change in national output over time. Thedefinition says that, Economics is concerned with determining the pattern of employment of scarceresources to produce commodities over time. Thus, the dynamic problems of production have been

brought within the purview of Economics.

2. Dynamic allocation of consumption: Similarly, under this definition, Economics is concerned with thepattern of consumption, not only now but also in the future. Thus, the problem of dividing the use of incomebetween present consumption and future consumption has been brought within the orbit of Economics.

3. Distribution: The modern definition also concerns itself with the distribution of consumption amongvarious persons and groups in a society. Thus, while the problem of distribution is implicit in the earlierdefinitions, the modern definition makes it explicit.

4. Improvement of resource allocation: The definition also says that, Economics analyses the costs andbenefits of improving the pattern of resource allocation. Improvement of resource allocation and betterdistributive justice are synonymous with economic development. Thus, issues of develop ment of a lessdeveloped economy have also been made subjects of the study of Economics.


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To put it summarily, the modern definition of Economics is the most comprehensive of all the definitions. Allthe issues that were highlighted in the earlier definitions are included here. In addition, the issues ofdevelopment of a backward economy, as well as those of growth in a mature capitalist economy, form partof this definition. Economics as it stands today is built on the basis of this comprehensive definition.

CONCLUSION

Thus, Economics means Home Management. The head of a family faces the problem of managing theunlimited wants of the family members within the limited income of the family. In fact, the same is true for asociety also. If we consider the whole society as a family, then the society also faces the problem oftackling unlimited wants of the members of the society with the limited resources available in that society.

Thus, Economics means the study of the way in which mankind organises itself to tackle the basicproblems of scarcity. All societies have more wants than resources. Hence, a system must be devised toallocate these resources between competing ends.

Economics is the study of how societies use scarce resources to produce valuable commodities anddistribute them among different people.

But economics concerns itself not just with how a nation allocates to various uses its scarce productiveresources, important as that may be. It also deals with the process by which the productive capacity ofthese resources is increased and with the factors which in the past have led to sharp fluctuations in the rateof utilization of resources.

Thus, the term Economics was applied to a frugal use of ones limited resources and the term Economyto the manner in which a particular society organized its resources for the maximum production of desiredgoods and services. Economics, thus studies how people earn income and resources and how they spendthem on their necessities, comforts and luxuries. It is also the study of the way in which mankind organisesitself to tackle the basic problems of scarcity. All societies have more wants than resources.

Hence, a system must be devised to allocate these resources between competing ends. In other words,economics analyses how a society utilizes its scarce resources of manpower, raw materials, and capital tosatisfy the material wants of its members.

But economics concerns itself not just with how a nation allocates to various uses its scarce productiveresources, important as that may be. It also deals with the process by which the productive capacity ofthese resources is increased and with the factors which in the past have led to sharp fluctuations in the rateof utilization of resources.

Economics formulates theories, laws, and principles relating to various aspects of production, distributionand consumption. In other words, it is the study of the way in which people (society) with scarce resourcesproduce, distribute and exchange goods and services in an economy. These activities direct and regulatethe day-to day human behaviour. In this sense, we can regard economics as a social science, whichinvestigates what, how, why, and for whom goods and services are produced.


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Economics also postulates and suggests practical methods to solve basic societal problems like managingscarce resources in the midst of unlimited human needs and wants. This task still remains the principalobjective in every research as well as debate in economics.

SCOPE OF ECONOMICS

1. Consumption: Satisfaction of human wants is called consumption which forms one of the importantbranches of economics. This tells how people behave in consumption of goods and services in order tomaximize their satisfaction.

2. Production: Goods and services have to be produced with the help of factors of production. So,production is another branch of economics. It concerned with how maximum goods are produced withminimum cost or how the scarce factors could be utilized economically for better results.

3. Exchange: Goods and services cannot be produced at one place or at one point of time. Goodsproduced by one are exchanged for the goods produced by the others. So, exchange forms another branch

of study in economics.

4. Distribution: Goods and services are produced with efforts, i.e., by combining the factors of production.These efforts have to be paid for or rewarded. The land gets rent, the labor get wages, the capital getsinterest and the organizer gets profit. This branch of study is called distribution in economics.

5. Public Finance: This branch of study in economics studies about the sources of revenue to thegovernment and the principles governing the expenditure for the benefit of the people. It also stud ies aboutpublic debt and financial administration.

Economics as a Science:A science is a systematized body of knowledge ascertainable by observationexperimentation. It is a body of generalizations, principles, theories or laws which traces out a casualrelationship between cause and effect.

Economics is a systematized body of knowledge in which economic facts are studied and analyzed in asystematic manner. For instance, economics is divided into consumption, production, exchange,distribution and public finance which have their laws are theories on whose basis these departments arestudied and analyzed in a systematic manner.

Hence economics is a science like any other science which has its own theories and laws which establish arelation between cause and effect. Economics is also a science because its laws possess universal validitysuch as the law of diminishing returns, the law of diminishing marginal utility the law of demand, Greshams

law, etc. Again, economics is a science because of its self corrective nature. It goes on revising itsconclusions in the light of new facts based on observations. Economic theories or principles are beingrevised in the fields of macro economics, monetary economics, international economics, public finance andeconomic development.

BASIC CONCEPTS OF ECONOMICS

Concept of scarcity


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According to Robbins, Economics is the science which studies human behaviour as a relationship between

cads and scarce means which have alternative uses.

When we analyze this definition, we find out that i t lays down three basic prepositions which comprise the

main structure of Economic Science. These three are:

Economic scarcity means that people do not have as much as they desire. The problem of scarcity arises

as a result of the fact that, at any point in time, the productive resources available in any society are limited,

whereas human wants are unlimited. Resources such as raw materials are in finite supply and must be

allocated to their best use.

Virtually all resources are scarce, meaning that more of them are desired than is available. It follows thatthe amount of goods and services that can be produced are limited and inadequate to meet human wants.

Here the Scarcity is to be interpreted in a relative and not in our absolute manner. The mere existence of

short supply does not lane a commodity scarce, if there is not demand for it.

Ends

Ends here refer to human wants. Our wants are unlimited in number the satisfaction of one want

immediately gives rise to another. In view of the multicipility of wants were never reach a stage when al the

wants of a person are fully satisfied except after death. Since they are unlimited we have to choose

between more urgent and less urgent wants.

Choice

Choices become necessary as a result of scarcity. Making a choice implies giving up something in order toget something else. The concept of choice relates to all the three main economic agents in the economy.

An individual consumer must choose among types of goods and services, between present andfuture consumption because of his limited money income.

The firm must choose what to produce and how to produce within constraint imposed by its limitedresources. Businesses and governments also deal with opportunity costs. Businesses must choosewhat type of goods to produce and the quantity. Given limited funds, the opportunity cost ofproducing one type of good will arise from not being able to produce another.

The government must decide what public goods and services to provide for the people given itslimited revenue as projected in the budget documents.

Scale of Preference

It is described as a list of all wants to be satisfied arranged in order of priority importance. The concept ofScale of Preference underscores the basic assumption in economics that every economic agent exhibitsrational behaviour in the process of making a choice.


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Opportunity Cost

Economists used the term opportunity cost to mean the next best alternative forgone in the process ofmaking a choice. To an individual consumer, the opportunity cost of a commodity bought is the next most

desirable commodity he could have bought instead. The relevant cost of any decision is its opportunity cost- the value of the next-best alternative that is given up. This will mean that if we choose more of one thing,we will have to have less of something else. Economists use the term opportunity cost to explain thisbehaviour. The opportunity cost of any action is the value of the next best alternative forgone. By makingchoices in how we use our time and spend our money we give something up. Instead of following theeconomics classs, what else could you be doing?

Your best alternatives may involve sports, leisure, work, entertainment, and more. Thus, the concept ofopportunity cost is your best alternative to the choice that is made. If you choose to go to a restaurant thisevening, the money that you spend on dinner will not be available for other uses, even saving.The concept of opportunity cost is central to the study of economics because it guides the individual, the

firm or the government to make rational decision on the use of scarce resources. Opportunity cost isalternatively referred to as real cost or economics cost.

For example, a housewife desires a tin of rice and a tin of beans each selling for $200. But since she hadonly $200, she decided to buy a tin of rice. The opportunity cost of a tin of rice bought is a tin of beansforgone.

Note that, the accountants review of cost i.e. (accounting cost) is quite different from the economist s viewof cost i.e. (opportunity cost). To the accountants, the cost of a commodity purchased by the consumer or afactor of production purchased by the firm is the amount of money paid to have that commodity orproductive resources. This is called money cost or accounting cost.

FUNDAMENTAL ECONOMIC PROBLEMS

Economic Problem: Due to the scarcity of means and the multiplicity of ends, the economic problem lies inmaking the best possible use of our resources so as to get maximum output satisfaction in the case of aconsumer and maximum output or profit for a producer. Hence economic problem consists in makingdecisions regarding the ends to be pursued and the goods to be produced and the means to be used forthe achievement of certain ends. Thus, there are five fundamental or central problems to be addressed byevery economic system.

Central Problems of An Economy

There are five fundamental questions relating to the problem of economy and they are discussed below.

1. What to produce and in what quantities? To make a decision of what goods and services are to be created and the volume of productivityhas to be determined and this is the first problem relating to economy. This involves allotment ofscarce resources in relation to the composition of total productivity in the economy. Since


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resources are inadequate the society has to decide about the goods to be produced. If the societygives significance to the production of more consumption goods now, it will have less in future. Ahigh precedence on capital goods implies consumer goods now and more in future. But sinceresources are inadequate, if some goods are produced in abundance, some other goods will haveto be produced in smaller quantities. It will therefore have to choose among mixture which will give

higher level of satisfaction.

2. How to produce these goods? The next problem is how to fabricate these goods. That is the techniques and methods to beapplied in the production of the necessary goods. This problem is principally dependent on theaccessibility of resources within the economy. If land is available in abundance, it may havewidespread cultivation. If the labour is in abundance, it may use labour demanding techniqueswhile in case of labour shortage, capital intensive techniques may be used. On the other hand easyconsumer goods and small outputs necessitate small and less costly machines. Further it has tomake a decision of what goods and services are to be created in the public sector and that in

private sector.

3. For whom are the Goods Produced? The third basic problem is for whom the goods and services are to be produced. That is theallotment of goods among the members of the society. The allotment of basic customer goods orsupplies and lavish comforts and among the household takes place on the basis of among theallocation of country's income. A rich person may have a large share of the lavish goods and apoor person may have more amounts of the basic consumer goods he needs.

4. How efficiently are the resources being utilised? This is one of the significant basic problems because of having made the three earlier decisions,the society has to see whether the capital it owns are being utilised fully or not. In case theresources of the financial system are lying idle. It has to find out ways and means to use them fully.If the idleness of resources, say man power, land or capital is due to their male allocation, thesociety has to adopt such monetary, fiscal or physical measures where this is corrected. In aneconomy where the available resources are being fully utilised, it is characterised by technicalcompetence or full employment. To maintain it at this level, the economy must always beincreasing the productivity of some goods and services by giving up something of others.

5. Is the Economy Growing? The last and the most imperative problem is to find out whether the economy is growing throughtime or is it sluggish. Economic growth takes place through a superior rate of capital configurationwhich consists of restoring existing capital goods with new and more productive ones by adoptingmore well-organized production techniques or through modernization. Economic growth enablesthe economy to have more of both the goods.

SUMMARY


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All these central problems of a financial system are interconnected and mutually dependent. They arisefrom the essential fiscal problems of insufficiency of means and array of ends which lead to the crisis ofchoice or economising of resources.

1. What to produce: The first major decision relates to the quantity and the range of goods to be

produced. Since resources are limited, we must choose between different alternative collection of goodsand services that may be produced. It also implies the allocation of resources between the different types ofgoods. Example: Consumer goods and capital goods.

2. How to produce: Having decided the quantity and the type of goods to be produced, we must nextdetermine the techniques of production to be used. Example: labor intensive or capitalintensive.

3. For whom to produce: This means how the national product is to distributed, i.e., who should get howmuch. This is the problem of the sharing the national product.

4. Are the Resources Economically Used? This is the problem of economic efficiency or welfare

maximization. There is to be no waste or misuse of resources since they are limited.

5. Problem of Full Employment & Growth: Another problem for an economy is to make sure that it keepsexpanding or developing so that it maintains conditions of stability. It is not to be static. Its productivecapacity must continue to increase. If it is an under developed economy, it must accelerate its process ofgrowth. Also, fullest possible use must be made of the available resources. In other words, an economymust endeavor to achieve full employment not only of labor but of all its resources.

ECONOMIC SYSTEMS

An economic systems describes the mechanisms by which scarce resources are allocated in society, bothfor production and distribution, the nature of the relationship between the individual and society and the roleof government in allocation of resources and the direction economic activity (Donnelly, 1991).

Functions of an Economic System

All economics perform the following functions

(i) Allocation of Resources: Every economy has to decide what and how much good and services toproduce at any given time.

(ii) Organisation of Production: Every economic system must decide what alternative techniques of

production are more suitable to its circumstances.

(iii) Distribution of Goods and Services: How the goods are shared among people is determined in everyeconomic system.

(iv) Economic Growth and Development: The mechanisms to grow the economy and raise average livingstandard as determined in each economy.


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(v) Economic Stability: Every economic system had mechanisms designed to control fluctuations in thelevel of economic activity e.g. using fiscal and monetary policies.

1.5.1 Types of Economic System

The three main types of economic system capitalism, socialism and mixed economy are explained in thissection.

CAPITALIST SYSTEM

Capitalism is that profit-oriented system which is characterized by private ownership of objects of laborinstruments of labor and means of labor. Production is mainly carried out with the help of labor servicesrendered by the working class in return for wages and the class of capitalists has the right to whateveroutput is produced within the system.

Characteristics of the capitalist system:

1. Private ownership of means of production : Under the capitalist system anything which helps man inthe production process like machinery, tools, land, raw-materials, etc. is owned by the capitalist class.

2. Production for the market: Under capitalism business firms produce mainly with the aim of selling theoutput in the market. Wherever any good is produced for the market it is termed as a commodity and anyeconomy in which production is undertaken with the sole object of exchange is call a commodity economy.

3. Price mechanism: In a capitalist economy neither an individual nor any institution takes decisions in aplanned manner concerning its day-to-day functioning. That is, there is no conscious effort to arrive atsome kind of solution to its central problems.

4. Labor power as a commodity: In a capitalist economy, majority of the people own only on thing viz.,their capacity to work or their labor power.

5. Exploitation of labour: Workers are exploited under capitalism. Very often due to the freedom grantedto the workers at a formal level, many people are wrongly given to believe that the workers by bargaining inthe free market are able to get a fair price in return for their labor power.

6. Growing wealth of the capitalists: In a capitalist economy the wealth of the capitalist class increases ina sustained manner.

7. Emergence of the working class: Under capitalism the increasing used of machinery leads towidespread unemployment and an increase in the rate of exploitation of workers which implies a decline inthe share of workers in the national income over time.

8. Class contradiction: Hence, the two major classes found in a capitalist society are those of thecapitalists and the workers. The clash of interests of the capitalists and the workers take the form of theclass conflict with the further development of capitalism.

Advantages


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(i) Optimal allocation of resources: Producers engage their resources only on those goods which appearto yield maximum profits.


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(ii) Greater output and higher income: There is increase in production and productivity leading toincrease in income, saving and investment.

(iii) Increase in efficiency: The presence of competition leads to a better use of resources to obtain costadvantage.

(iv) Progress and Prosperity: Intense competition promotes invention and innovation thereby bringingeconomic growth and prosperity.

Disadvantages

(i) Emergence of Monopoly: Cutthroat competition may force small firms who could not cope to shutdown while the big firms may merge and monopolise the market charging exorbitant prices.

(ii) Inequality problem is worsened: The rich who own resources and control production are favouredwhile the poor become more impoverished.

(iii) Inefficient production: More resources are allocated to the production of frivolous goods that are

desired by the rich who have the means while the basic necessities required by the poor are in sho rtsupply.

(iv) Economic depression and unemployment: Excessive competition and unplanned production leadsto excess supply, low price level and cut in the number of workers employed.

SOCIALISM

Under socialism not only is there social ownership of the means of production but also the functioning ofthe economy is such so as to maximize social benefit rather than private benefit. Unlike capitalism in a

socialist society the market mechanism does not play the all dominating role of determining the type andquantity of various commodities produces their priority sequence and the necessary allocation of resources.

Characteristics (or) Salient features of the socialist economic system:

1. Social ownership of the means of production: In a socialist society private ownership of the means ofproduction is abolished in the various sectors of the economy.2. Predominance of public sector: An important precondition for the establishment of socialism is theexistence of the public sector which is founded on the principle of social ownership of the means ofproduction

3. Decisive role of economic planning : Economic planning under socialism plays exactly the same roleas is played by the price mechanism in a capitalist economy.

4. Production guided by social benefit: In a socialist economy, however, income inequalities aredrastically reduced so that everyone has an adequate amount of disposable income. While determining thepattern and size of output the planning commission has to see to it that its decisions in this regard are suchthat they ensure the availability of commodities for all in the market.


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5. Abolition of exploitation of labor: Once the development of human society reaches the stage ofsocialism. Exploitation of man by man comes to an end.

(b) Advantages

i. Greater economic efficiency: The government ensures that resources are allocated to those sectorswhere they can be used most productively. Therefore, production efficiency is greater than undercapitalism.

ii. Absence of Wasteful Competition: Duplication of goods and services or use of resources on extensiveadvertisement campaign is avoided.

iii. Less Inequality of Income: Every member of the society is taken care of within the limits of theirrelative capabilities and the overall resources of the state.

iv. Exploitation of Private Monopoly if avoided : State monopoly exists only to promote overall welfare ofthe people.

(c) Disadvantages

i. Misallocation of Resources: Resources allocation is based on trial and error and selfish interest of theruling class leading to underproduction of goods required by the poor majority.

ii. Loss of Consumers Sovereignty: Consumers are restricted to only the goods and services dictatedfor production by the state.

iii. No Freedom of Enterprise: Every person is employed by the government and there is tendency forunderemployment misallocation of human resources.

iv. Waste of Resources: Central Planning requires large bureaucratic structures which waste resources.

v. Poor Quality Product: The absence of competition weakens the drive for producers to improve onproductsquality.

MIXED ECONOMY

According to Samuelson, a mixed economy is characterized by the existence of both public and privateinstitutions exercising economic controls.

CHARACTERISTICS OF A MIXED ECONOMY:

1. Private and state ownership of the means of production and profit induced private business : In amixed economy people enjoy right of property through constitutional provisions.

2. Decisive role of market mechanism: Market mechanism has a predominant position in a mixedeconomy. In such an economy markets exist not only for various products, but also for productive factors,such as labor and capital.


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3. Interventionist role of the state: The market mechanism is a mixed economy may not be entirely freefrom state control. Often legislative measures are undertaken to provide a regulatory system for industrialactivity in the country.

4. Public sector activities are supposedly guided by social benefit: Activities of the public enterprises

are considered to be guided by the social benefit. Thus performance of these enterprises is often judged onthe criterion of social benefit and thus most of this enterprise ignore profit maximization goal.

5. Supportive role of economic planning: The role of economic planning in basically capitalisticeconomic framework is supportive. Hence planning in these economies is usually indicative in nature.Economic planning in developing economies, in which both private and public sectors co - exists, hasnothing to do with socialism.

Advantages

i. Best allocation of resources. A mixed economy combines the good features of both capitalism andsocialism. Therefore, the resources of the economic are utilized in a way that ensures the adequacy of alltypes of goods and services and production efficiency increases,

ii. General Balance. The competition and cooperation between the public sector and the private sectorfavours the realization of a high rate of capital accumulation and economic growth.

iii. Welfare State. In a mixed economy, there is no exploitation either by the capitalists or by the state.

Government agencies are established to protect consumersinterest, while legislative measures areadopted to reduce poverty and inequalities of income and wealth.

Disadvantagesi. Non-cooperation between the private and the public sector. In reallife, publicprivate sectorpartnership to promote economic progress is hardly found. Most often, the private sector is subjected toheavy taxes and restrictions that impact negatively on its performance, while the public sector is givensubsidies and preferences.

ii. Inefficient public sector. The public sector of a mixed economy works inefficiently due to bureaucraticcontrol, over-staffing of the personnel, corruption and nepotism. As a result, resources are misutilised andthe level of production is low.

iii. Economic fluctuations. Periods of economic prosperity and hardship alternating which arecharacteristic features of a capitalist economy are equally experienced in a mixed economy. This is a result

of the improper mixture of the features of capitalism and socialism.

PRODUCTION POSSIBILITY CURVE

The Production Possibility curve is the laws of output combinations which can be obtained from givenquantities of factors or inputs. This curve not only shows production possibilities but also the rate of


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transformation of one product into the other when the economy moves from one possibility point to theother.

Assumptions:

i. Only two goods X (Consumer goods) and Y (Capital goods) are produced in different proportions in theeconomy.

ii. The same resources can be used to produce either or both of the two goods and can be shifted freelybetween them.

iii. The supplies of factors are fixed. But they can be re-allocated for the production of the tow goods withinlimits.

iv. The production techniques are given and constant.

v. The economys resources are fully employed and technically efficient.

vi. The time period is short.

This is explained with the help of a diagram. X axis-Product X Y axis- Product Y PPC-Production PossibilityCurve

(i) Scarcity. The boundary formed by the curve joining points A and F indicates that there is limit to theamount of both rice and better, the country can produce, at any point in time, with available resources andtechnology.

(ii) Fullemployment. Any point on the PPC (such as A to F) shows the combinations of the two goodsthat the economy can produce given that all available resources are fully and efficiently utilized.

(iii) Unemployment or underemployment. Any point inside the PPC, such as G. Shows that someresources are either left completely idle (unemployed) or are not efficiently utilized (underemployed).

(iv) Unattainable output level. Any point outside the curve, such as H, shows the output level that cannotbe achieved by the country.

(v) Opportunity cost. The slope of the PPC usually referred to as marginal rate of transformation (MRT)measures the opportunities cost of a unit more or less of a commodity.

(vi) Economic growth. It can be defined as a sustained increase in the production capacity of an economywhich leads to a greater output of goods and services. This is represented by an outward shift in theproduction possibilities curve from PPC 1 to PPC2 in Figure 1.3.


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Explanation:i. The curve production possibility (PP1) depicts the various possible combinations of the two goods,P,B,C,D and P1. This is also known as the transformation curve or production possibility frontier.

ii. The production possibility curve further shows that when the society moves from the possibility point B to

C or to D, it transfers resources from the production of good X. It is concern as the optimum product =mixof a society.

iii.Again, all possibility curve combinations lying on the production possibil ity curve (such as B, C and D)show the combinations of the tow goods that can be produced by existing resources and technology of thesociety. Such combinations are said to be technologically efficient.

iv.Any combination lying inside the production possibility curve, such as R implies that the society is notusing its existing resources fully. Such a combination is said to be technologically inefficient.

v.Any combination lying outside the production possibility frontier, such as K, implies that the economy

does not posses sufficient resources to produce this combination. It is said to be technologically infeasibleor unobtainable.

THE USES OR APPLICATIONS OF THE PRODUCTION POSSIBILITY CURVE

i. Unemployment: The production possibility curve helps in knowing the level of unemployment ofresources in the economy.

ii. Technological Progress: The production possibility curve helps in showing technical progress enablesan economy to get more output from the same quantities of resources.

iii. Economic growth: The production possibility curve helps in explaining how an economy grows.

iv. Present goods vs. Future goods: An economy that allocates more resources in the present to theproduction of capital goods than to consumer goods will have more of both kinds of goods in the future. Itwill there, experience higher economic growth. This is because consumer goods satisfy the present wantswhile capital goods satisfy future wants.

v. Economic efficiency: The production possibility curve is also used to explain the three efficienciesnamely efficient selection of the goods to be produced, efficient allocation of resources in the production ofthese goods and efficient choice of methods of production, efficient allotment of the goods produced amongconsumers

vi. Basic fact of human life: The production possibility curve tells us about the basic fact of human life thatthe resources available to mankind in terms of factors, goods, money or time are scarce in relation towants, and the solution lies in economizing these resources.

principles of economics unit 1

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