Economics 1 A

UNIT 2
1. Production possibility curve Video https://youtu.be/Ed_fwWxstKE

The economic principles of scarcity, choice and opportunity cost are captured in the production possibilities
curve. The production possibility curve shows the maximum amount of production that can be produced by
an economy with a given number of resources.

Maximum Number of potatoes

but no fish
Scarcity and Unattainable
point

K or any space inside the curve

k represents inefficiency but
40kgs of potatoes for attainable
1 basket of fish

Maximum Number of fish but

no potatoes

 The PPC curve represents the ECONOMIC problem – Scarcity

 a production possibility curve indicates to us a combination of two products that we can manufacture with
a given amount of inputs
 Meaning with a set number of resources we can either create one product or the other with those
allocated resources
 The curve line is the PPC Curve

 Scarcity is illustrated by the fact that all points to the right of the curve (outside the curve) are
unattainable
 Choice is illustrated by the need to choose between the combinations available, and
 Opportunity cost is illustrated by the negative slope of the curve.
 The negative slope, showing that more of one good can only be obtained by sacrificing the other good.
Opportunity cost increases as we move along the PPF. This can be seen by paying attention to the
concave shape of the curve.
 Any point of the curve represents efficiency and the items opportunity costs (What was sacrificed of one
item to make another)
 K: Inside the curve represents inefficiency – More can be achieved
 Can also represent unemployment as not full labour force in action

2. Explain the reasoning why opportunity costs increase along the production possibility frontier

 This occurs for the most part, because it is difficult to move resources from one industry to another.
 Resources do not adapt easily. Workers may not have the same skills across the industries, so as we
move them from one industry to the other, we get fewer of one good for every other good that is
given up.
 There are difficulties in transferring labour, skills, capital, and entrepreneurship between industries.
These difficulties are so well known that they are often referred to as the law of increasing
opportunity cost.

The law off increasing opportunity cost: states that ever-increasing quantities of other goods and services
need to be given up in order to get more of a particular good.

This law is not solely based on the lack of movement of skilled labour.

The mix of factors required to make a certain good is also a factor. One good may require a more capital-
intensive production process as opposed to the other.
 3. More PPC curve info

A-F on the curve Maximum Number of

represents the
A potatoes but no fish
boundary frontier –
the maximum and B The curve line is the PPC Curve Scarcity is illustrated by the fact
what is attainable
C that all points to the right of the
G curve (outside the curve) are
unattainable
D Outward Movement
illustrates economic Growth

H H or any space

Sacrifice 40kgs
inside the E
curve Any point of the curve represents
of potatoes for represents efficiency and opportunity costs
1 basket of fish inefficiency but
attainable

F Maximum
Number of fish
but no potatoes

A-F

 A-F on the curve represents the boundary frontier – the maximum

 With a given level of resources and a given state of technology, the community can produce various
combinations of fish and potato output.
 Cannot move beyond the points ABCDEF this is why the curve is sometimes called a production
possibility boundary of frontier.
 It shows the maximum attainable combinations of goods that can be produced, or potential output. Its
concave shape (from the origin) indicates increasing opportunity costs.
 When production is taking place on the production possibilities curve it shows Full and efficient utilization
of scarce resources
 Actual output is equal to potential output when production takes place on the production possibilities
curve

H
 Any combination within the frontier is attainable,
 Inefficient because either available resources are not being used to their full potential (inefficiently) or
some of them are left idle (unemployment).
 When the economy is operating at less than potential output (actual output is therefore less than
potential output), this would be illustrated as a point inside the production possibility curve/frontier
(PPF). Some of the available resources are either unemployed or not employed efficiently.
 At a point such as H, more output of one good would not require less output of the other, there would be
no opportunity cost when output is expanded. It is therefore possible to expand production by simply
using the existing resources fully and more efficiently (given the state of technology).

 G is unattainable. Any point beyond AF is unattainable. With the given available resources and current
production techniques, achieving a combination such as G or any combination outside of AF is impossible.

Movement

 However, if over time the quantity of available resources increases, and/or production techniques
improve, then points beyond AF will be attainable. If this happens then the PPF will shift outwards.
Outward movements of the PPF illustrate economic growth.
4. SWIVELS AND SHIFTS

Maximum of non-effected SWIVEL: Only one item has an improved technique

item stays the same

Resources are shifted and

thus possible combinations
would increase

Maximum of effected item

Increases

SWIVEL: When techniques improve for one of the options. The maximum output would increase of that item.
The maximum of the other would stay the same, however the combination options would increase

A PPC curve swivels if you have one point of your PPC curve that remains constant and then it rotates and for
the other product you find that there is a change in the quantity being produced. This is usually an indication
that there has been an improvement in way the one product is being produced. Using the same resources
more can now be created.

SHIFT:

Inward Shift: Decline – Reduction in resources affecting both good will cause the maximums of both goods to
decline and the PPC to move inwards.

Outward shift: Growth. The increase in resources effecting both goods will cause the maximum of both goods
to increase and the PPC to move outwards.
5. The three central economic questions

A. What should be produced? The problem of resource allocation

The purpose of economic activity is to satisfy human wants. Goods and services satisfy most wants.

 Goods are tangible objects like food, clothing, houses, and books.
 Services are intangible things like medical services and legal services.

We assume that all goods and services are useful and as such maximum production is desirable.

CONSUMER GOODS: Are good that are used or consumed by individuals or households to satisfy wants.
Examples: Food, wine, clothing etc.

CAPITAL GOODS: are goods that are not consumed in this way but are used in the production of other good.
Examples: machinery, plant, and equipment. Capital goods do not themselves yield consumer satisfaction, but
they permit more production and satisfaction in future. They depreciate

FINAL GOODS: are the gods that are used or consumed by individuals, household, and firms e.g.: a loaf of
bread.

INTERMEDIATE GOODS: are goods that are purchased to be used as inputs in producing other goods. E.g.:
Flour for bread.

The decision about what to produce incorporates the decision about how much of each good and service to
produce.

B. How it should be produced?

After deciding what goods and services are to be produced, the next step is to decide how the goods and
services will be produced.

Scarce resources have to be used efficiently. What are these resources?

Resources used to produce goods and services are called factors of production.

There are four main factors of production:

 Natural resources (land, minerals) – primary
 Labour – primary
 Capital - secondary
 Entrepreneurship –secondary

o Natural Resources (land) PRIMARY

Consists of gifts of nature, some examples are mineral deposits, water, natural forests, animal life and
sunshine. Natural resources are in fixed supply; however, it is possible to exploit more of the available
resources. The discovery of new mineral deposits is an example.
However, once used these resources cannot be replaced. As a result, minerals are referred to as non-
renewable or exhaustible assets. As is the case with all the factors of production, both quality and the
quantity of natural resources are important.

o Labour PRIMARY
Labour can be defined as the exercise of human and physical effort in the production of goods and services.
The quantity available depends on the size and proportion of the population which are willing and able to
work. The quality of labour is described by the term human capital, which refers to the skill, knowledge, and
health of the workers. Education, training, and experience are all determinants of human capital.

o Capital
Comprises of all manufactured resources (machines, tools, and buildings), which are used in the production of
other goods and services. Capital goods are not produced for their own sake; they are produced to produce
other goods. When we talk about capital as a factor of production, we are referring to all those tangible things
used in the production process. When we produce capital goods, we sacrifice present consumption for future
consumption.

o Entrepreneurship
Factors of production must be combined and organized by people who see opportunities and are willing to
take risks by producing goods in the expectation that they will be sold. Entrepreneurs are the people who do
this. They are the initiators, the innovators, and the risk bearers, and they do this in anticipation of making
profits.

o Technology
Sometimes identified as the fifth factor of production. When new knowledge is put into practice, and more
goods and services are produced with a given level of natural resources, labour, capital, and entrepreneurship,
we say that technology has improved.

o Invention is the discovery of new knowledge

o innovation is the incorporation of the new knowledge into actual production.

o Money as a factor of production?

Although money is important, it is NOT a factor of production. Goods and services cannot be produced with
money, to produce goods and services we need factors of production. Money is a medium of exchange; it
facilitates the exchange of goods and services.
The Choice of Technique

When deciding how to produce the goods and services chosen by society one has to make a choice as to what
the best method of production will be.

Production often involves more than one technique with which to produce the good or service, for example
when manufacturing shoes one may choose a process which is dominated by machines or a process which
requires more labour than machines.

o If the production process is dominated by machines, the production process is referred to as capital-
intensive.
o However, if the emphasis is on labour, the production process is labor-intensive.

In choosing whether or not to have a capital intensive or labor-intensive production process certain factors
play a role in the decision, these factors include:

o the availability of resources, the quality of the resources available,

o the relative prices of the resources available (i.e., the price of labour against the price of capital),
o the labour laws of the country and other relevant laws.

C. For whom it should be produced

Good and services are produced for:

o government (the public sector) and

o the rest of the economy (the private sector).

There is also a geographical distribution of the income between regions of a country and between sectors
(known as primary, secondary and tertiary sectors).

o In a command economy, decision of who receives goods and services is centralized and under the
control of the state. In other words, it is the government who allocates goods and services and FOP.
o In a free market economy, the decision is decentralized to private individuals and businesses in the
economy. It is the market mechanism (price) that allocates goods and services and FOP.
o In a mixed economy, both the government and the market mechanism play a role in the allocation of
resources. – SA IS A MIXED ECONOMY

Video https://youtu.be/7j-WklCTD2I
ECONOMIC SYSTEMS

The traditional system

 The oldest solution to the three central questions is tradition. By this we mean that the same goods
are produced and distributed in the same way by each successive generation. In a traditional system,
each participant’s task and methods of production are prescribed by custom. Men do what their
fathers did. Women do what their mothers did.
 People use the same techniques of production as their parents did and production is distributed
according to long established traditions.

A traditional economic system:

 provides clear and easy answers to the three central questions.

 A rigid system, which is slow to adapt to changing conditions and stubbornly resists innovation.
 Traditional systems tend to be subsistence economies.
 Economic activity is not the first priority it is secondary to religious and cultural values and the desire
to perpetuate the status quo.
 Not as common as they used to be.

The command system

 In a command system the participants are instructed what to produce and how to produce it by a
central authority which also determines how the output is distributed.
 Because the economy is governed and coordinated by a central authority, command systems are also
called centrally planned systems.
 A tremendous task.
 Decisions have to be taken on how, where and for what purpose every natural resource, every laborer
and every capital good are to be applied.
 The planners have to determine
 In the 1970s and early 1980s more than a third of the world’s population lived in countries that relied
heavily on central planning. These countries included Russia, China, Poland, Romania, North Korea
and East Germany.
 Often described as socialist or communist systems.
 Central planning refers to the way in which economic activity is coordinated, while socialism and
communism refer to the ownership of the factors of production
 In a pure socialist system, all the factors of production except labour are owned by the state.
 In a pure communist system, all resources are in principle owned by everybody – everything is
common property.
The market system

In a market system the method of coordination is so subtle and intricate that it could not have

been invented. It simply happened.

A market is any contact or communication between potential buyers and potential sellers of a good or service.

Any institution or mechanism which brings potential buyers (“demanders”) and prospective sellers
(“suppliers”) of particular goods and services into contact with each other is regarded as a market.

For a market to exist, the following conditions have to be met:

 There must be at least one potential buyer and one potential seller of the good or service.
 The seller must have something to sell.
 The buyer must have the means with which to purchase it.
 An exchange ratio – the market price – must be determined.
 The agreement must be guaranteed by law or by tradition.

In practice, sellers usually fix their prices, and prospective buyers shop around to find the best bargain.

A market system is one in which individual decisions and preferences are communicated and coordinated
through the market mechanism (i.e., the mechanism which meets the conditions listed above).

The most important elements of this mechanism are market prices. Market prices are signals or indices of
scarcity which indicate to consumers what they have to sacrifice to obtain the goods or services concerned.

At the same time market prices also indicate to the owners of the various factors of production how these
factors can best be employed.

However, the types of goods and services produced also depend on the distribution of income – the
consumers with the most “money votes” have the largest impact on demand, market prices and the structure
of production. They therefore dominate the outcome of the market processes.

 Market systems are often called capitalist systems.

Like socialism, capitalism refers to a particular type of ownership of the factors of production.

Whereas most factors of production in a socialist system are owned by the state (or by society at large), a
capitalist system is characterised by private ownership.

In market capitalism, economic activity is driven by self-interest. Consumers want to maximise their
satisfaction. Businesspeople wish to maximise their profits. Workers want the highest possible income for a
given amount of work.
Review Questions

1. Define economics:
 Economics is the study of how our scarce productive resources are used to satisfy human ones
 The study of how to provide for needs and infinite (Unlimited) wants with given or finite (Limited)
resources.
 Economics is a social science that studies human behaviour as a relationship between ends and scarce
means which have alternative uses.

2. Define opportunity costs and use an example to explain it.

 Opportunity cost can be defined as the cost of the alternative we have chosen in terms of the
alternative that we have to sacrifice.
 an example of opportunity cost would be if Tony has to choose between studying and going to the
movies, the opportunity cost of studying would be the visit to the movies that he had to forego.

3. Define a production possibility curve and use such a curve to illustrate scarcity, choice and opportunity
cost.
 The production possibility curve also known as a production possibility frontier can be defined as
an illustrated aid showing scarcity choice an opportunity cost.
 The production possibilities curve indicates the combination of any two goods or services that are
attainable with communities resources are fully and efficiently employed

4. Distinguish between microeconomics and macro economics and give two examples of micro economic
issues and two examples of macro economic issues in South Africa today.
 Microeconomics focuses on the individual participants in the economy example producers’
workers employers and consumers whilst macro economics is concerned with the economy as a
whole.
 An example of microeconomic issues could be the demand supply and price of individual goods
and services specific markets example cars.
 An example of macro economic issues could be the evaluation of economic growth in the country
employment rates and inflation.

5. Use an example to explain the difference between the level of a variable [example price or wage) and the
rates of change in the same variable.
 A rate of change is a rate that describes how one quantity changes in relation to another
quantity. If x is the independent variable and y is the dependent variable, then rate of change =
change in y/change  in  x
  Example: The price level is a measure of the average price in an economy and is measured at a
point in time. The rate of inflation is the rate of change of the price level over time. Strictly
speaking, economists define inflation as a continued increase in the price level as opposed to a
one-time price level adjustment.

6. Explain why economics is classified as a social science.

 Economic defiance like any other science economics involves a systematic attempt to discover
regular patterns of behavior these patterns are used to explain what is happening to predict what
might happen an assist policymaker to devise or choose appropriate economic policies. Next time
economics is a social science it studies the behaviors of human beings both individually and as a
group.

7. Explain the difference between consumer goods and capital goods and give at least two examples of each.
 Consumers of goods that are used or household examples would include food, clothes shoes etc.
 Capital goods are goods that are not consumed in this way but are used in the production of
other goods. Examples include all types of machinery plants and equipment used in
manufacturing.

8. What does ceteris paribus mean?

 Ceteris paribus is the Latin term for “all things being equal inverted commas”