Central Problem

Conceptual Outline

• Wants (Unlimited) > Limited Resources
• Leads to Scarcity
• Forces us to make Choices
• Resulting in Opportunity Cost
• Illustrated by Production Possibility Curve

Scarcity

Refers to the situation where the limited resources available are unable to satisfy the unlimited human wants

Unlimited Wants

• Refer to the desire for ever higher levels of consumption
• Increase over time (Once satisfied, new wants created)
• Satisfied through consumption of goods (tangible) and services (intangible)

Limited Resources

• Means of production, finite in amount at any time
• Limits quantity of output
• 4 categories:

1. Land: Natural resources/ productive resources made available to mankind by nature
2. Labour: Human effort, mental/ physical, used in production of goods and services. Quality of labour depends on human capital (knowledge and skill from education, On-the-Job Training, work experience)
3. Capital: Stock of physical assets, man-made to aid production of goods which are demanded directly by consumers
4. Entrepreneurship: Organises Land, Labour and Capital in production. Come up with new ideas, make business decisions, bear risks.

Choice

3 fundamental choices to make:

1. What and How Much to produce: Type and amount, allocation of scarce resources
2. How to produce: Method of production, varies according to aim and resources. Aim to choose most efficient method of production, use resource to fullest
3. For Whom to produce: Give to those who want products most

Opportunity Cost

The cost of any activity measured in terms of the next best alternative foregone

• May or may not coincide with the money expenditure of the activity
• Zero opportunity cost:

1. Free Good: Abundant (not scarce) in nature, no scarce resource used to produce it, price = zero
2. Single use factors: Only one particular use

Production Possibility Curve

• Definition: The PPC shows all the different MAXIMUM attainable combinations of goods or services that can be produced in an economy, when ALL the available RESOURCES are USED FULLY and EFFICIENTLY, at a given STATE OF TECHNOLOGY
• Assumptions:

1. Economy only produces 2 goods or services
2. Production is observed over a specific time period
3. Quantity and quality of resources used remain the same over the specific time period
4. Resources fully employed and efficiently utilised
5. No change in the level of technology

• Points inside PPC attainable but inefficient because resources not fully employed or used inefficiently
• Points outside PPC preferred but unattainable because present resources and technology is limited
• Illustrates:

1. Scarcity: Points outside PPC unattainable
2. Choice: Only one point can be chosen
3. Opportunity Cost: Downward sloping nature
4. (Productive) Efficiency: Points on the PPC

Economic Efficiency

Achieved when each good is produced at the minimum cost and where individual people and firms get the maximum benefit from their resources.

• Both productive and allocative efficiency need to be achieved
• Allocative efficiency: Combination of goods produced that gives the maximum value (benefit) to society (consumers & firms)
• Only 1 point on the PPC
• Need to know marginal costs and benefits of set of goods produced
• MC=MB=Allocative efficient (KIV: Market Failure)

Concave PPC (common)

• Law of Increasing Opportunity Cost: States that as more of a particular good is produced, large and larger quantities of the alternative good must be sacrificed
• Opportunity cost increases because resources in the economy are not perfectly homogenous
• More specialised resources – greater rate of increase of opportunity cost

Straight-line PPC

• Constant opportunity cost: Refers to the situation where the rate at which the good is exchanged for another is constant
• Only possible if all units of the resource are equally skilled in the production of all the goods

Shifts in PPC

• Outward shift: Economic growth, parallel (resource altered perfectly adaptable to production of both goods) or pivotal (resource better suited only to production of one good)
• Increase in quantity of available resources – increase ability to produce more goods and services. May arise from:

1. Labour: Population growth (larger workforce), greater participation
2. Land: Discovery of mineral deposits through intensive exploration
3. Capital: Increased production of capital goods will increase future output, decrease current consumption
4. Entrepreneurship: Incentives for starting businesses

• Improvement in the quality of available resources:

1. Labour: Improvement in skills (higher education/ training); Incentivise hard work
2. Land: Application of fertiliser; Irrigation schemes; improved production techniques
3. Capital: Technological improvement (includes discovery of new methods of production); only possible with greater expenditure on R&D

Law of Comparative Advantage

A person has a comparative advantage in an activity if that person can perform the activity at a lower opportunity cost than anyone else

• Different opportunity costs due to different individual ability and different characteristics of resources

Summary

1. Central economic problem is scarcity
2. Choices have to be made because resources have alternative uses
3. For every choice, there is opportunity cost
4. Scarcity, choice, opportunity cost and efficiency illustrated by Production Possibility Curve
5. Points on PPC illustrate full employment, points inside PPC illustrate underemployment/ unemployment
6. Concave and straight-line PPCs illustrate increasing and constant opportunity cost respectively
7. PPC shift outwards due to greater amount of resource available, technological improvement and increased capital stock
8. Comparative advantage is a situation in which one person’s opportunity cost of producing a good is lower than another’s. Individuals and firms can gain from specialisation and exchange
9. Productive efficiency: situation where firms produce maximum output for given amount of input, or given output at least cost
10. Allocative efficiency: situation where current combination of goods produced and sold gives maximum satisfaction for each consumer at current income level