Introduction to Economics

• Basic economic problem

• Basic economic questions
• Opportunity cost
• Production Possibility Curve (PPC)
• Shapes and description of PPC curve
• Shifts of the Production
• Possibility Curve(PPC)
• Normative and positive statements
• Efficient resource allocation

Introduction to economics
• Economics is the study of how scarce resources are allocated to meet unlimited needs
and wants.
• Resources are inputs that are used by firms and individuals for the production of goods
and services.
• Goods are tangible items that satisfy human needs and wants.
• Example of goods are furniture, books, food and clothes.
• Services are activities that are carried out by firms and individuals in order to satisfy
needs or wants.
• Examples of services are hair-cutting, health care and teaching.
• Economic resources include land, labour, capital and entrepreneurship/enterprise.
• Economic resources are the limited resources which are used in the production of goods
and services.
• Economic resources can also be called factors of production.
• Misallocation of these resources leads to business failure.

Factors of production
• Four factors of production are land, labour, capital and entrepreneurship.
Land

• Land refers to all natural resources used in the production process.

• These include water, forests, soil, trees and fisheries.
• Land is a limited resource which is supposed to be carefully allocated.
Labour

• Labour is the human mental and physical effort that is used in the production process.
• Production is a process of converting inputs into outputs.
• Outputs are goods or services that are produced by firms and individuals.
• Examples of labour include teachers, lawyers, engineers and economists.
Capital

• These are man-made resources used to produce goods and services.

• They include machines, buildings, tools and factories.

Entrepreneurship/enterprise
 • Entrepreneurs combine all the other factors of production (land, labour and capital) to
produce goods and services.
• Enterprising skills and knowledge are required to facilitate efficient and effective
production.
• Entrepreneurs create business plans, acquire resources and manage their businesses.
What are limited resources?

• Limited resources means that there is always a shortage of factors of production

required by firms and individuals for production purposes.
• This makes factors of production a part of the central problem of scarcity.
Needs

• A need is anything that is required and that one cannot do without.

• For instance, if one doesn’t eat, he or she will eventually die. This makes food a need or
a necessity.
• However, there are different types of food that may not be classified as needs. Examples
are chocolates or ice cream. One can do without them.
• Other examples of needs are shelter, water, air, clothing and health care.
Wants

• A want is anything that one would like to have but it is not a necessity.
• A want is a good item to have but a person can leave without it.
• An example of a want is music. One does not require music in order to survive.
However, music is still required to make life enjoyable.
Unlimited needs and wants

• Unlimited needs and wants means that people have a lot of desires which cannot be met
by the limited resources available.
• Human needs and wants are never satisfied using available resources
• Satisfaction is a process of fulfilling human needs and wants.
• Therefore, unlimited resources are part of the central problem of scarcity.
Scarcity

• Scarcity refers to a situation where there are limited resources available to satisfy
unlimited needs and wants.
• Scarcity is the basic economic problem.
• Therefore, economics seeks to allocate those limited resources to meet unlimited needs
and wants.

• unlimited needs and wants outweigh the available limited resources.

• Therefore, scarcity is when human needs and wants outweigh the available resources.
• Scarcity of resources will then force people to make choices.

• Due to limited resources, individuals, firms and government make their choices on how
best they can use the available resources to meet their needs and wants.
• For instance, a country may want to improve the education system by purchasing new
textbooks for schools or to improve its health facilities by purchasing medical drugs. Due
to limited resources, the government may choose to purchase medical drugs instead of
buying textbooks for schools.
 • This means that due to the scarcity of resources, the government has made a choice
between the two options.

Summary

• Economics is the study of how scarce resources are allocated to meet unlimited needs
and wants.
• Economic resources include land, labour, capital and entrepreneurship/enterprise.
• Limited resources are also known as scarce resources.
• People have needs and wants which must be satisfied.
• A need is anything that is required and that one cannot live without.
• A want is anything that one would like to have but it is not a necessity.
• Due to the problem of scarcity, individuals and firms need to make choices.

Basic economic questions

• The existence of scarcity creates the basic economic problem faced by every society,
which in turn leads to the derivation of the basic economic questions.
• Good decisions must be made on how to make the best use of limited productive
resources to satisfy human needs and wants.
• To solve this basic economic problem, every society must answer these three basic
economic questions:
o What to produce,
o How to produce it,
o And for whom to produce.

Fig 1.1.1:

Basic economic questions

What to produce?

• What goods are to be produced with the scarce resources, for example:
 o Should we produce bananas or oranges?
o Should we produce petrol powered cars or solar powered cars?
o Should we produce military weapons or better hospitals?
o Should we produce coal fired electricity or solar electricity?
How to produce?

• Given that we have basic resources of labour, land and capital, an economy should
decide on how we should combine them to produce the goods and services that we want.
• How to produce deals with methods of production.
• For example, should we use more labour than capital to produce or should we use more
capital than labour to produce?
For whom to produce?

• Once we have produced goods and services, we then decide on how to distribute them
among the people in the economy.
• For example, will people consume them on a first-come, first-served basis or basing on
the ability to pay.
• Should goods be allocated basing on religion, age, gender, race, looks, strength, health
or wealth?
Summary
• All economic societies have to answer three economic questions:
o ‘What should be produced?’
o ‘How shall it be produced?’
o ‘For whom to produce?’

Opportunity Cost
• The problem of scarcity leads people and firms to make choices on the use of the
available resources. Choice leads to opportunity cost.

• Opportunity cost is the next best alternative foregone.

• When a choice is made between two options, opportunity cost is the value of the product
foregone.
• Opportunity cost only applies to economic goods and services.
• An economic good is a product which benefits the people and it has a degree of scarcity
in relation to its demand.
• Due to scarcity, economic goods have an opportunity cost.
• Take for instance, bricks used to build a house could have been used to construct a
classroom block.
• Therefore, the opportunity cost of building a house is the classroom block that could
have been built with the same resources.
• On the other hand, free goods do not have an opportunity cost since they are in abundant
supply.
• This means that free goods have zero opportunity cost.
• Free goods are natural and are found in large quantities.
• Air is an example of a free good. If one breathes, there will still be enough air for
everyone else to breathe.

Scarcity, choice and opportunity cost

Fig 1.2:
Scarcity and Choice

• The problem of scarcity, choice and opportunity cost can be explained using a
production possibility curve (PPC).
• Production possibility curve shows combinations of goods that an economy is able to
produce given available resources.
• Ceteris paribus,the production possibility produces only two goods in an economy.
• Ceteris paribus means holding all other things constant.

Assumptions of the PPC are;

• Only two goods are produced.

• Factors of production are limited.
• All resources are used efficiently.
• There are no changes in technology and production techniques.

Construction of the PPC

• Since there is an assumption that an economy only produces two goods, let’s assume
that there is production of food and clothes.
• Table 1:1 below shows the quantities of food and clothes produced in an economy.

Table 1.1:Goods Produced in an Economy

CLOTHES(UNITS) FOOD(UNITS)
0 125

40 100

80 75

100 50

110 0

• From the table above, one can tell that when there is zero production of clothes, there
will be 125 units of food produced.
• The opportunity cost of producing 125 units of food is the 110 units of clothes foregone.
o If we produce 110 units of clothes, 0 units of food will be produced. Hence, the
opportunity cost of producing 110 units of clothes is 125 units of food foregone.
• It can also be noted from table 1.1 above that, the opportunity cost of one good increases
as the production of another good decreases.
• As more food is produced, less clothes will be produced.
• When the production of food increases from 50 units to 75 units, the opportunity cost is
20 units of clothes foregone.
• The information in the above table can be used to construct the following production
possibilty curve.

Fig 1.3: Production Possibility

Curve

• The PPC shows the combinations of food and clothes that an economy can produce with
the available resources.
• Points X, Y and Z show the best possible combinations of output that can be produced
when all resources are fully employed.
 • These points show the attainable combination when there is full utilization of available
resources.
• The firms in the economy desire to produce at Point B but is unattainable due to limited
resources available at the moment.
• The production within the PPC, for example Point A, shows the under-utilization of the
available resources.
o At this point, there is inefficient allocation of available resources in the
economy.
• Points e and f are the extreme combinations where all resources are used to produce
only one good.
• At point e, only clothes are produced, whereas at point f only food is produced.
• Therefore, points A, B, X, Y, Z, e, and f explain different choices that can be made.
• Fig 1.4 below explains opportunity cost.

Fig 1.4
Production Possibility Curve

• The highest quantity of goods that can be produced is along the curve.

Efficiency

• The points along the production possibility curve (PPC) indicate efficient allocation of
resources
Fig 1.5: Production Possibility Curve

• Therefore, using fig 1.5, points A and B indicate efficiency in the allocation of
resources.
• Efficient allocation of resources means that all available resources are fully utilised.
• Full utilisation of resources can also be referred to as Pareto efficiency or Pareto
optimality.
• Pareto optimality is a state of resource allocation where it is impossible to make one
preference better off without making another preference worse off.
• In other words, the production of food cannot be made better off without making the
production of clothes worse off.
• Point C is an attainable point but there is under-utilization of resources. Hence there is
inefficient allocation of resources.
• Therefore, points inside the PPC indicate inefficient allocation of resources.
• All points along the PPC indicate efficient allocation of resources.

Shapes and Descriptions of the PPC

• The curved line is called Production Possibility Frontier (PPF) – other names of it
include
o Production Possibility Curve.
o Transformation curve.
• Production possibility curve shows the maximum combinations of goods and services
that an economy is able to produce with available resources.
• The difference between the shapes of the PPCs depend on the opportunity cost.
• Production Possibility Curves can take different shapes.
• The curves can be in the form of Concave PPC, Convex PPC or Constant/Straight Line
PPC.

Concave PPC

o Most of the PPF curves are concave due to the inadaptability of resources.
o The law of increasing opportunity cost states that as the production of one good
rises, the opportunity cost of producing that good increases.
 o The increase in the opportunity cost indicates that more units of a good are
traded off for the other.
o An example of a concave PPC is shown in Fig 1.1

Fig 1.1:
Concave Production Possibility Curve (PPC)

• If all resources in the economy are fully and efficiently employed, the country will
produce:
o At point C, producing 30 units of manufactured goods and 30 units of non-
manufactured goods,
o At point D, producing 35 units of manufactured goods and 20 units of non-
manufactured goods,
o At point A, devoting all of its resources to the production of non-manufactured
goods,
o At point E, devoting all of its resources to the production of manufactured goods.
• Point F denotes that the economy can produce any combination but this will mean that
some resources are unemployed.
• Any point outside the PPC is unattainable with available resources.
• Thus, the production possibility curve illustrates clearly the principle of opportunity
cost.

Convex PPC

o The PPC curve can be convex to the origin when the opportunity cost decreases.
o This can happen only when less and less units of first commodity are foregone
when there is production of an additional unit of another commodity.
o An example of a convex PPC is shown on Fig1.2
Fig 1.2:
Convex Production Possibility Curve

• The convex line ABCDEF shows increasing returns or (decreasing cost).

• The ratio of exchange of X for Y gets better as we move towards the ends of the line.
• In fig 1.2, moving from position A to position B involves giving up 20 units of Y to gain
6 units of X
• The next 20 units of Y given up gains 8 units of X.
• As stated above, a production possibility line will take a convex shape.

Constant/ straight line PPC

o If the opportunity cost is constant, a straight-line (linear) PPF is produced.

o If two products use similar methods of production, there may be constant
opportunity cost.
o The Production Possibility Curve will be a straight line as illustrated in Fig 1.3.

Fig 1.3: Straight line Production

Possibility Curve (PPC)

• Fig 1.3 illustrates constant opportunity cost. For example, product X can be exchanged
for product Y at a constant rate.
 • For example, if a country is producing 60 units of good Y, it also produces 60 units of
good X.
• If production of good Y increases to 80 units, there will be a reduction of good X from
60 units to 40 units.
• Therefore, a 20 units increase in good Y results in 20 units decrease of good X.

Shifts of the Production Possibility Curve

• An economy’s production potential will constantly change over time.
• The PPC can shift either inwards or outwards.

Outward shift of the PPC

o Over time, economies are able to achieve economic growth by shifting their
production possibility curve outwards
o If its capacity to produce goods and services increases, the production
possibility curve will shift outwards to the right as shown in Fig1.4.

Fig 1.4:
Outward shift in the production possibility curve

• An economy will be able to produce more goods and services if the quantity and/or
quality of its resources increase.
• The rightward shift can be caused by the following factors:
o An increase in the labour force.
o An increase in the stock of capital goods - machinery, offices, power stations,
factories, transport networks.
o An increase in technical knowledge and an improvement in training.
o Technological advancement.
o Discovery of new resources used in production.

Inward shift of the PPC

o The PPC can shift inwards if an economy’s production potential declines.

o Fig 1.5 illustrates the inward shift of the PPC.
Fig 1.5:
Inward shift in Production Possibility Curve (PPC)

• The inward shift can be caused by the following factors:

• War or political instability.
• Natural disasters for example floods, earthquakes or droughts.
• Under-utilisation of resources.

Efficient resource allocation

• Efficient resource allocation refers to how scarce resources are distributed among
producers.
• It also deals with how scarce goods and services are distributed among consumers
• In Economics, raw materials, equipment and human labour are all resources needed for
production.
• Unless these resources are efficiently utilized, an economy will not grow.
• Resources are limited and hence should be utilized optimally.
• Resource allocation is the process of dividing up and distributing available, limited
resources to satisfy unlimited wants and needs.
• Effective resource allocation means that the available resources are utilized with
minimal to no waste during the different processes.
• In order to achieve optimal resource allocation, it is important to determine how much is
needed as compared to how much is available.

Sustainable resource allocation

o Sustainable resources are a type of renewable resource.
o These are resources which can be exploited economically but do not diminish or
run-out.
o Some examples of renewable resources are forests, water and fish stocks.
o Sustainable resource allocation focuses on the supply, demand and allocation of
the earth’s natural resources in a way that the resources do not deplete.
o It is the goal of the government to allocate these sustainable resources efficiently
in the economy.
o The government should balance the economy, society and the environment to
achieve efficiency.
Fig 1.7:
Subsets of the environment

• Fig 1.7 illustrates that the society and the economy are subsets of the environment.
• It is not possible for the societal and economic system to exist independently from the
environment.
• For this reason, sustainable resource allocation focuses on allocating these natural
resources in order to develop a sufficient and sustainable economy.

Positive and normative statements

Positive statements

• Positive statements are statements that are objective and fact based.
• Examples of positive statements are:
o Unemployment rate in Zimbabwe is 30%.
o If the government of Zimbabwe raises the duty on imports, this will lead to a fall
in imports in the country.
• These examples are based on facts and they can be tested, proven or disproven.
• If proven, it means that the statement is consistent with the theory.
• Therefore, positive statements are not supposed to be true always but they can be proven
whether they are correct or wrong.

Normative Statements

• They are based on value judgment.

• These statements are based on people’s opinions and individual preferences rather than
facts.
• They usually use the terms ‘might’ or ‘should’ or ‘ought’.
• Examples of normative statements are :
o Pollution ought to be the most significant economic problem in Zimbabwe.
o People are more worried about unemployment than inflation.
• These statements express individuals’ opinions but they are not based on facts.
Summary

• Economics is focused on finding means of dealing with the economic problem of

scarcity.
• The problem of scarcity, choice and opportunity cost can be explained using a
production possibility curve (PPC).
• A production possibility curve shows combinations of goods that an economy is able to
produce given available resources.
• Opportunity cost which is also called alternative cost, refers to the best alternative
foregone.
• Firms that produce along the PPC use their resources efficiently.
• Efficient allocation of resources means that all available resources are fully utilised, a
point where it is impossible to make one preference better off without making another
preference worse off.
• In economics, positive statements are different from normative ones.
• Positive statements are statements that are objective and fact based, whereas normative
statements are based on people’s opinions and individual preferences rather than facts.