CHAPTER 2: THE ECONOMIC

PROBLEM
LAW SIONG HOOK/ MOHD NASEEM NIAZ AHMAD

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 Learning Outcomes
• Explain the production possibilities frontier and apply it to calculate
opportunity cost.
• Distinguish between production possibilities and preference.
• Identify an allocation of efficient resources.
• Illustrate how existing production choices enlarge future production
possibilities.
• Describe how trade and specialization expand production possibilities.
• Clarify market economy and the circular flow.

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 PRODUCTION POSSIBILITIES
FRONTIER (PPF)
• Production possibilities frontier (PPF) –
• refers to the boundary between the combinations of goods and services that
can be produced with given available resources and those that cannot be
produced.

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 PPF: PRODUCTION EFFICIENCY
 There is trade-off between the production of the two
commodities that the economies possess

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 PPF: PRODUCTION EFFICIENCY

• At point Z:- inside frontier (Z)

is inefficient.

• At point Y:- outside frontier (Y)

is unattainable.

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 PPF: OPPORTUNITY COST
• Moving down (up) along the PPF –
more (less) hand phones and less
(more) computers are produced
“trade-off”.

• Note that the opportunity cost of

hand phones is the inverse of the
opportunity cost of a computers.

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 PPF: OPPORTUNITY COST
• Increasing opportunity cost
• Since resources are unequal in the production process:
• increase in the production of each good will also increase its opportunity cost => the
PPF bows outward.

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 GAINS FROM TRADE
• Any country in the world attempt to produce at minimum costs & to
obtain higher profits.

Comparative advantage:
• if individual or country can produce a given commodity at a lower
opportunity cost (OC) than the other country.

Absolute advantage:
• refers to the country’s capability to produce a given product more efficiently
than its counterpart.

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 GAINS FROM TRADE

• Mary's opportunity cost of producing 1 computer is 1 hand phone.

• Mary’s customers buy computers and hand phones in equal number,

so she produces 15 computers and 15 hand phones an hour.

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 GAINS FROM TRADE

• Henry's opportunity cost of producing 1 computers is 5 hand phones.

• Henry’s customers buy computers and hand phones in equal number,
so she produces 5 computers and 5 hand phones an hour.

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GAINS FROM TRADE

 Henry’s has a comparative

advantage in producing hand
phone.

 Mary’s has a comparative

advantage in producing
computer.

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 GAINS FROM TRADE

At point A – without trade:

 Mary produces 15 hand phones and 15 computers as indicated at point A
 Henry produces 5 hand phones and 5 computers as indicated at point A
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 GAINS FROM TRADE

With opportunity to trade:

• Mary specializes in producing computers –at point B
• Henry specializes in producing hand phone –at point B
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 GAINS FROM TRADE

 Trade line – along the red:

• Mary produces computers & buys hand phones from Henry – moves to point C
• Henry produces hand phones & buys computers from Mary – moves to point C
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GAINS FROM TRADE

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THE MARKET ECONOMY
Economic Coordination

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