Principles of Economics

Production Possibility Curves

Five people stranded in the jungle where there are only two natural sources of food: coconuts and fish. With the equipment they have they find that each person can collect four coconuts or catch two fish in an hour. They decide they will all work for three hours per day.

1. Draw the daily production possibility curve (PPC) for this economy

The above graph represents the production possibility curve of this economic model. If all the members of the society spend an hour collecting coconuts, at the end of this period they will have 20 coconuts without any fish. On the other hand, if they spend an hour collecting fish, as a result they will be able to collect 10 fish. The members are working for 3 hours per day so for each day they will collect 60 coconut or 30 fish as shown in the graph above. The along the curve is the combination of both coconut and fish that can be collected when the member are operating efficiently.

2. At the end of the first working day, the group has collected 30 coconuts and 10 fish. Is the group working efficiently? - No

When the economy is working efficiently during one hour they are supposed to collect 2 coconuts and 1 fish each. Thus, during one hour the group is supposed to collect 10 coconuts and 5 fish per hour. In case when they are working for 3 hours per day, they are expected to collect 30 coconut and 15 fish. The given data shows that they collected 30 coconuts and 10 fish indicates that the group collected fewer fish than expected hence the group is not working efficiently.

3. Imagine that three of the group decide that they are too afraid of heights to climb coconut trees, while the other two are afraid of water and therefore unable to go fishing. Draw the PPC and explain the implications of this.

If three members of the group do not climb coconut tree and two others do not go fishing the PPC will change. During one hour, they will be able to collect 6 fish and 8 coconuts, and since they are working for 3 hours per day then they will be able to collect 18 fish and 24 coconuts which is represented by point X in the graph. This combination is inside the curve showing that the group is not utilising all available resources. The best combination is along the original curve.

4. Draw a production possibility curve for an economy assuming that there are only two possible goods, Capital Goods and Consumer Goods.

Consumer Goods

The above diagram shows a production possibility curve that describes production of two types of goods, i.e. capital goods and consumer goods. Point A shows the level of capital goods that will be produced if all resources are utilised in producing only capital goods while point B shows the level of consumer goods if all resources are used in producing consumer goods. Along the curve is the combination of capital goods and consumer goods produced when the economy is operating efficiently.

1. Mark on your diagram a point showing unemployed resources

The resources are unemployed at point x, this is because by employing the existing resources more can be achieved up to the level of the curve, at this point the resources are laying idle without being utilized.

2. Mark on your diagram a point that is not available to the economy in the short term.

The unavailable resources are at point y, at this point no resources can be added to the economy in the short run but in the long run more resources like capital, and labour can be added and this point can be attained.

3. Explain the process by which the choices that you make can cause economic growth in the long term.

In the long term, each individual choice may cause the economic growth. For example, it could be done by increasing investment that leads to inflow of capital into economy. This in turn causes increase of production, supply and employment. All the above in the long-term activity will help to provoke economic growth since employment can increase productivity. Also full utilizing of available resources can push economic growth in the long term.

Basic Economic Problem

Choose the best answer in each case. Then explain this answer and why you rejected the others.

Which one of the following is a normative statement (i.e. based on an opinion)?

1. Economic resources are classified as land, labour, capital and enterprise.
2. Oil is a scarce resource.
3. Resources are distributed unfairly.
4. Gold is distributed unequally.

The statement ‘Oil is a scarce resource’ is a normative one because it tells us about “what ought to be” and the value of oil. The rest of the statements are not normative since they are telling us “what is” and they do not describe the value of the resources.

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An economy is productively efficient if it maximises:

1. Average living standards.
2. Output per unit of input
3. Investment
4. Employment

An economy is productively efficient if it maximises output per unit of input. In any economy to be effective, the output should be maximised in relation to input. As a result, the cost will be minimised since there will be no many wastes. Average living standard correlates with the quality of life in a country and ensures that people are satisfied with the way they live. Investment is the resource that is put into the economy in order to increase an output and employment in a form of labour that is required for the goods and services production.

Explain the Basic Economic Problem and Apply Your Knowledge to Your own Country

The main basic economic problem is the problem of scarcity and choice. Economic resources are scarce and countries should make decision about their choice. Each economy should make the choice of what goods and services to produce, of the best way of their production in connection with the scarce resources, and finally of the expected consumers of the produced goods and services. Making choice involves trade off; it means when someone gives up one commodity in order to get something else. For example, people are making choice whether to buy a house or rent it. Each decision has advantages and disadvantages, and both involve risks. In addition, when people choose how to travel and which transport to use, all means of transport have advantages and disadvantages. At last, people choose on working and studying, full time or part time. Scarcity and choices are main economic problems, with which countries should deal in order to have an economic growth.

Supply and Demand

Conditions of Demand and Supply

• Explain (giving an example for each factor) what factors might cause demand for a product to change.

The following factors cause changes in demand: price of substitutes, future expectation, changes in income, population, weather, and tastes and preferences.

Price of substitutes depends on a price of a particular product. If the product’s price increases, it leads to decrease in its demand. At the same time, it affects increasing in the demand for its substitutes because they could be cheaper in the market. For example, increase in price of second hand clothes leads to increase in demand for new clothes.

If the prices are supposed to increase in future, people will demand more now to reserve for future. The same situation is when prices are expected to reduce due to an increase in supply; it may lead to current low demand in anticipation of reduction of price. For example, when people expect increasing in price of sugar they intend to buy in bulk, thus making demand to increase.

Changes of weather also influence the demand. For example, during cold season people need warm clothes and hot drinks. These needs increase the demand for sweaters, jackets, coffee and other hot beverages as compared to hot season when cold drinks such as sodas and juices have a higher demand.

Changes in income also affect the demand, i.e. the amount of disposable income available for spending influences demand in certain goods and the amount purchased.

• Explain (giving an example for each factor) what factors might cause supply for a product to change.

Many factors lead to change of supply and of quantity supplied. Price is the only factor that changes the quantity supplied so that increase in price leads to increase in quantity supplied. For example, increase in price of maize in the market may provoke sellers to sell from their stock because of fear that the price will fall again.

Change in supply comes together with changes in input costs thereby increase in production cost may lead to additional expenses. Thus, reduction in amount produced will lead to reduction in amount supplied to the market. For example, increase in price of fruits to produce fresh juice may lead to reduction in the amount produced. Hence, while the price of the same fruits decrease, an amount available for sale may lead to low costs and increase in production.

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Technology also plays a major role in terms of supply. Improved technologies such as tractors, threshing, and milling machines increase production and an amount available for the market. And vice versa, when farming is manual it results in low production, small amounts for market and a lot of inconveniences.

Government actions affect the supply of a particular product through taxes, subsidies, total ban and other regulations. For example, imposing heavy tax charges on a company producing cigarettes implies that the cost of production increases; this discourages producers and leads to reduction in supply. On the other hand, subsidy encourages producers to increase production and thus increase supply. Other government rules and regulations may interfere with the supply. For instance, rules and regulation on the importation of raw materials may influence the amount available for production and thus affect supply in the market.