Three

Economic
Problems
Dr Vighneswara Swamy

1
THREE MAIN ECONOMIC
PROBLEMS
1. What to produce?
2. How to produce?
3. For whom to produce?

Dr. Vighneswara Swamy 2

 WHAT TO PRODUCE?
 Human wants are unlimited, while resources are limited.

 The satisfaction of human wants requires the consumption of goods and services.

 Only finite amounts of a limited number of goods and services can be produced.

 The economy must choose its production plan carefully

 Hence, what goods and services are to be produced in a society and in what quantities?

Dr. Vighneswara Swamy 3

 HOW TO PRODUCE?
 A particular quantity of a particular good or service can be produced
in many different ways. The economy must choose a particular way
of producing the specified amount of the good.

 A particular way of producing a particular good or service (or a set of

goods and services) is called a technique of production

 The question ‘how to produce’ is also known as the problem of

choice of techniques.

Dr. Vighneswara Swamy 4

FOR WHOM TO PRODUCE?
 After the commodities have been produced, there remains
the task of deciding how they will be distributed. Who will
consume the produced commodities?

 “For whom to produce?” is also known as the problem of

distribution.

Dr. Vighneswara Swamy 5

 PRODUCTION POSSIBILITIES
FRONTIER (PPF)
 Production possibilities frontier (PPF) is the boundary between the
combinations of goods and services that can be produced and the
combinations that cannot be produced, given the available resources and the
state of technology.

 PPF is a model used to highlight and clarify scarcity, and issues such as
efficiency, trade-offs, opportunity cost and growth, which are associated
with scarcity.

 The PPF is a valuable tool for illustrating the effects of scarcity and its
consequences.

 The PPF illustrates three features of production possibilities:

1) Attainable and unattainable combinations
2) Full employment and unemployment
3) Trade-offs
Dr. Vighneswara Swamy 6
 PRODUCTION POSSIBILITIES
CURVE At this point what is being
produced in greater quantity?

How many
Papads are being
produced at this
point?
Robots
Why does the production of Representation of
these two products follow a production at its
curve?
• It is bowed out to denote most efficient
increasing costs

Important to realize that production Papads

can also take place anywhere within the
curve. Dr. Vighneswara Swamy 7
Production Possibilities Curve
Why would the curve shift
inward?

Robots
• Problems with Labor
• Loss of Land Resources
• Machinery Breaks Down

When the economy/business

uses less resources than the
economy is capable of using
it experiences…Underutilization.
Underutilization

Papads 8
Dr. Vighneswara Swamy
PPF: EFFICIENCY
Allocative Efficiency Productive Efficiency

Resources must be allocated Production must be carried

to the production of goods & on in the least costly way.
services that people want the
most “getting the best mix”.

Dr. Vighneswara Swamy 9

PPF DIAGRAM The opportunity cost
A (how much of one good is
10 sacrificed to produce one
Any point on the frontier is
B Productively Efficient. of the other goods)
9
depends on how much of
Robots (1000’s) 8 It may or may not be each the economy is
C Allocatively Efficient producing.
7

6 In this example, as more

papads are produced the
5 opportunity cost of
D papads in terms of robots
4 Any point within the increases
I frontier is
3
productively inefficient
2
E
1

1 2 3 4 5 6 7 8

Papads (100,000’s) Dr. Vighneswara Swamy

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PRODUCTION POSSIBILITIES AT THREE PLANTS

The slopes of the production possibilities curves for each plant differ. The steeper the curve, the greater the
opportunity cost of an additional snowboard. Here, the opportunity cost is lowest at Plant 3 and greatest at
Plant 1.
Dr. Vighneswara Swamy 11
EFFICIENT VS. INEFFICIENT
PRODUCTION

When factors of production are allocated on a

basis other than comparative advantage, the
result is inefficient production. Suppose that all
three plants are devoted exclusively to ski
production; the firm operates at A.

Now suppose that, to increase snowboard

production, it transfers plants in numerical order:
Plant 1 first, then Plant 2, and finally Plant 3. The
result is the bowed-in curve AB′C′D. Production
on the production possibilities curve ABCD
requires that factors of production be transferred
according to comparative advantage.

Dr. Vighneswara Swamy 12

OPPORTUNITY COST
 Opportunity cost is the best alternative foregone for a
chosen option. This means no decision can be made
without cost.

 What is the opportunity cost of you being here as a

student?

 The most money that you could be making if you were

somewhere else instead of pursuing your education.

Dr. Vighneswara Swamy 13

Keywords
Three Economic 1. What to produce? 2. How to produce? 3. How to produce?
Problems

Production
possibilities PPF is the boundary between the combinations of goods and services that can be
frontier (PPF) produced and the combinations that cannot be produced, given the available
resources and the state of technology.
Allocative
Efficiency Resources must be allocated to the production of goods & services that people want
the most “getting the best mix”.
Productive
Efficiency Production must be carried on in the least costly way.

Opportunity Cost
Opportunity cost is the best alternative foregone for a chosen option.

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Dr. Vighneswara Swamy