1

INTRODUCTIONE

LEARNING OBJECTIVES
1.1 INTRODUCTION
1.2 SCARCITY
1.3 ECONOMIC PROBLEM
1.4 MEANING OF ECONOMICS
1.5 POSITIVE ECONOMICS AND NORMATIVE ECONOMICS
1.6 MICROECONOMICS AND MACROECONOMICS
1.7 CENTRAL PROBLEMS OF AN ECONOMY
1.8 OPPORTUNITY COST
1.9 PRODUCTION POSSIBILITY FRONTIER
1.10 SOLVED PRACTICALS
(PPF) X
1.1 INTRoDUCTION
Every field of study has its own language and its own way of thinking. For example, mathematics
talks about algebra, science deals with experiments, accounts deal with profit and loss and so
on. Economics is no different. An Economist's language consists of terms like demand, supply,

market, etc. In the coming chapters, you will come across many new terms and some familiar
words that economists use in specialized ways.
The most important purpose of this book is to help you understand an economist's way of
thinking. Of course, as one cannot become a mathematician overnight, in the same way, learning
to think like an economist will take some time. Yet with a combination of theory, numericals
and live examples, this book will give you ample opportunity to develop and practice this skill.

Before we proceed to the meaning of economics, let us first understand the meaning of economy and
reason for studying economics.

ta1stus
Whatis an Economy?
Lrou must have observed many activities happening around you in your daily life. For instance,
you may have seen factories, mines, shops, offices, flyovers, railways, etc. All these institutions
and organisations may be collectively called an economy. Such units enable people to earn an
income and, at the same time, help to produce goods and services which people require for use.
An economy is a system which provides people, the means to work and eam a lioing
1.1
1.2 Introductory Microeconomics
It is an organisation that provides living to the people. In this task, it makes use of the available
resources to produce those goods and services that people want. For example, Indian economy
consists of all sources of production in agriculture, industry, transport and communication,
banking, etc.
Vital Processes of an Economy
Economy is a system which provides living to the people, For this objective to be fulfilled, it is
necessary that kyery economy should undertak three economic activities:
1. Production
2. Consumption
3. Investment or
Capital Formation.
These economic activities are known as the essentials or the vital processes of an
economy.
On the basis of nature of economic activities, economies can be
and Centrally Planned Economy. It is
broadly classified as: Market Economy
given in Power Booster Section for knowledge enrichment.

Why Study Economics?

We go toa cinema hall to watch movie. We go to a restaurant to eat. We attend school to
a
get
educated or to be able to earn a living. It means,
every activity is conducted for a
specific reason.
Economics is studied because it enables us to understand different
aspects of the economy.
However, the main reason for
study of economics
can be
simplified
to a single word-Scarcity.
We all know, human wants are more than the available resources. So, there is a need to allocate
these scarce resources for the satisfaction of never
ending human wants. Hence, Economics is
concerned with selection of resources under conditions
of scarcity.
Let us nowunderstand the concept of 'Scarcity, the root of all economic
problems.

1.2CARCITY
LBcarcity refers to the limitation of supply in relation to demand fora commodity.
It refers to the situation, when wants exceed the available resources. As a result, goods are not
readily available and society does not have enough resources to satisfy all the wants of its
Scarcity is universal, i.e. every individual, organisation and economy faces people.
scarcity of resources.
Scarcity of resources calls for economizing of resources. Economizing of resources
making optimum use of the available resources. There is a need to economize, as werefers
to
have to
satisfy our unlimited wants out of limited resources.
Scarcity is not the only problem!
Limitation of resources is not the only
problem. In addition to being scarce, resources also
have alternate (different) uses. Alternate use
of
resources means that a resource can be put to
more than one use.
 Introduction 1.3

.For example, we all know, petrol is scarce in relation to its demand. But there is one more
problem. In addition to its scarcity, it is used not only in vehicles, but also in machines,
railway engines, airplanes, generators, etc.
.Whenever, a commodity is chosen for one use, other valuable uses will have to be rejected.
It gives rise to the problem of choice.

For, "Scarcty and Choice go together, refer HOTS.

13eONOMIC PROBLEM
Awe know, human wants are unlimited, but the means to satisfy them are limited. Therefore,
all our wants cannot be fulfilled. In order to maximise satisfaction, every consumer exercises
choice, as to which goods should be consumed and in what quantity. An economic problem is
basically a problem of choice.
Economic Problem is a problem of choice involving satisfaction of unlimited wants out of
limited resources having alternative uses.

Reasons for Economic Problem

The 3 main reasons for existence of economic problems are:

) Scarcity of Resources: Resources (i.e. land, labour, capital, etc.) are limited in relation to
their demand and economy cannot produce all what people want. It is the basic reason
for existence of economic problems in all economies. Scarcity is universal and applies
to all individuals, organisations and countries. There would have been no problem,if
resources were not scarce.
i) Unlimited Human Wants: Human wants are never ending, ie. they can never be fully
satisfied. As soon as one want is satisfied, another new want emerges. Wants of the people
are unlimited and keep on multiplying and cannot be satisfied due to limited resources.
Human wants also differ in priorities, i.e. all wants are not of equal intensity. For every
individual, some wants are more important and urgent as compared to others. Due to
this reason, people allocate their resources in order of preference to satisfy some of their
wants. If all human wants had been of equal importance, then it would have become impossible
to make choices.
(iii) Alternate Uses: Resources are not only scarce, but they can also be put to various uses,
It makes choice among resources more important. For exanmple, petrol is used not only
in vehicles, but also for running machines, generators, etc. As a result, economy has to
make choice between the alternative uses of the given resources.

Resources Vs Human Wants

Features of Resources:
i) They are scarce, i.e. their supply is limited in relation to demand.
(ii) They have alternative uses.

Features of Human wants:

a) They are unlimited, ie. they can never be fully satisfied.
() They differ in priorities.
1.4 Introductory Microeconomics
,1.4 JEANING OF ECONOMICs
Tconomics is a social science which studies the way a society chooses to use its limited
resources, which have alternate uses, to produce goods and services and to distribute them
among different groups of people.
Why Economics is considered a social science?
.The term Science' stands for any systematic and organised body of knowledge.
Economics is also a science as it is a systematic and organised study of economicC
behaviour of human beings.
However, it is not an exact science like Physics and Chemistry as it deals with the study
of human behaviour. Therefore, it is known as social science.

What is Economics all about?

Economics is all about making choices in the presence of scarcity. It studies human behaviour as a
relationship between means (resources) and ends (human wants). Economics aims to ensure
that the used in the best
resources are
possible manner.
1.5 POSITIVE ECONOMICS AND NORMATIVE ECONOMICS
Positive Economics (or Science)
Positive economics studies the facts of life, i.e., it deals with
'things as they are'. Positive
Economics deals with what are the economic problems and how are they actually solved. For
example, India is an overpopulated country or prices are constantly rising.
Positive statements describe what was, what is or what will be under the given state of
circumstances. These statements do not pass any value
judgements.
Positive Economics is neutral between ends
Positive economics remain strictly neutral with respect to ultimate ends. It avoids economic
value judgements. For example, a positive economic theory might describe that
manufacturing
and sale of cigarettes is injurious to health, but it does not
provide any instruction or
judgement
on what policy followed
ought to be to avoid cigarettes in an
economy.
According to Robbins, economics is not concerned with moral or ethical questions and economist
should analyse the things as they are and has no right to give judgement

Do not confuse statements of Positive Economics as statements of truth

Positive economics statements should not be confused as statements of truth. They may be true
or false. For example, If Paras says that India is the most populated country in the world and
Saksham says that China is the most populated country, then both are positive statements.
However, Paras is wrong and Saksham is right.

The point to be noted is that positive statements can be verified as true or false by comparing with
actual data.
Introduction
1.5
Normative Economics (or Science)
Normative economics tells us 'what ought to be'. Normative Economics deals with what
ought to be or how the economic problems should be solved. For example, India should not be
an overpopulated country or prices should not rise.
Normative economics discusses what are desirable things and should be realised and what
undesirable things and should be avoided. It
gives decisions regarding value judgements
ECONOMICS AS A SCIENCE

POSITIVE SCIENCE NORMATIVE SCIENCE

What is? .What ought to be?
What wasS? What should happen?
What will be? What should have happened?

Difference between Positive Economics and Normative Economics

Basls Positive Economics Normative Economics

Meaning It deals with what is or howthe economic It deals with what ought to be or how the
problemsare actually solved. economic problems should be solved.
Verification Itcan be verified with actual data. It cannot be verified with actual data.
Purpose It aims to make real description of an It aims to determine the ideals.
economic activity.
Suggestive It is based upon facts, and thus, not It is based upon individual opinion and
Suggestive. therefore,itis suggestivein nature.
Value t does not give any value judgements, | It gives value judgements.
Judgementsi.e. it is neutral betweenends.
Examples 1. Prices in Indian economy are 1. India should take steps to control
constantly rising rising prices.
2. There are inequalities of income in our 2. Income inequalities should be
economy. reduced.

1.6MICROECONOMICS AND MACROECONOMICS

The subject matter of economics has been studied under two broad branches:
1. Microeconomics (Price Theory) 2. Macroeconomics (Income Theory)
These two concepts have become of general use in economics. Let us discuss these concepts
in detail.

Microeconomics
Adam Smith is considered to be the founder of the field of microeconomics. The term 'micro'
has been derived from Greek word 'mikros' which means 'small'. Microeconomics deals with
analysis of behaviour and economic actions of small and individual units of the economy, like a
particular consumer, a firm or a small group of individual units. The concept of microeconomics
is very important as it supplies the foundation for most of our understanding of the functioning
of an economy.
1.6 Introductory Microeconomics
Microeconomics is that part of economic theory, which st1udies the behaviour of individual
units of an economy. For example, Individual income, individual output, price of a commodity,
etc. Its main tools are Demand and Supply.
Macroeconomics
The term 'macro' has been derived from the Greek word 'makros' which means 'large'. So,
macroeconomics deals with overall performance of the economy. It is concerned with study of
problems of the economy like inflation, unemployment, poverty, etc.
Macroeconomics is that part of economic theory which studies the behaviour
of aggregates of
the economy as a whole. For
example, National income, aggregate output, aggregate consumption,
etc. Its main tools are
Aggregate Demand and Aggregate Supply.
Micro Vs Macro
In Microeconomics, the letter T stands for
'Individuals', i.e. it studies the economic
behaviour of individuals.
In Macroeconomics, the letter A' stands for
a whole.
'Aggregates', i.e. it studies the as economy
Letus discuss the detailed differences between the two
branches of economics.
Difference between Microeconomics and Macroeconomics
Basis Microeconomicss Macroeconomics
Meaning Microeconomics is that part of economic
theory which studies the behaviour of Macroeconomics
is that part of
economic theory which studies the
individual units of an economy. behaviourof aggregates of the economy
as a whole.
Tools Demand and Supply.
Aggregate Demand and Aggregate
Basic Objective
Supply.
It aims to determine price of
a commodity |It aims to determine income and
orfactors of production.
employment level of the economy.
Degree of It involves limited
degree aggregation.
of
For example, market demand is derived |It
involves the highest degree of
Aggregation
by aggregating individual demands of |demandaggregation. For example, aggregate
is derived for the entire
all buyers in the
particular market. economy.
Basic It assumes all the macro
Assumptions variables to |It assumes that all the micro variables,
be
constant, i.e., it assumes that national like decisions of
income, consumption, savings, households and firms,
constant.
etc. are |prices individual products, etc. are
of

Other Name
constant.
| It is also known as 'Price Theory. It is also known as 'Income and
Examples Individual income, individual output.
Employment Theory.
National lIncome, National
output.
Interdependence of Microeconomics and Macroeconomics
Economics is a single subject and the
analysis of an economy cannot be split into two
watertight compartments. It means, microeconomics and macroeconomics
are not
each other and there is much common
ground between the two. It means, both
independent of
macroeconomics are interdependent. microeconomics and
Introduction 1.7
Let us elaborate their interdependence with the help of some examples:

Microeconomics depends on Macroeconomics

1. Law of demand came into existence from the analysis of the behaviour of a group
(aggregate) of people.
2. Price of a commodity is influenced by the general price level prevailing in the economy.

Macroeconomics depends on Microeconomics

individual units
1. National income of a country is nothing but the sum total of incomes of
of the country.
2. Aggregate demand depends on demand of individual households of the economy.

Micro-Macro Paradoxes
Paradox is a seemingly absurd or contradictory statement, though, ofteit a true statement. Sonmetimes,
there are paradoxes seen in Micro and Macro activities. It means, an act which is
beneficial for
an individual, may prove to be harmful for the economy as a whole.
it
Example: Ifan individual saves, his family will be benefitted, but if the whole economy starts saving,
result in contraction of demand, output, employment and income. As a result, the whole economy
will suffer

Which is more Important- Microeconomics or Macroeconomics?

Both, microeconomics and macroeconomics have a place of their own and none of them can be
of and
the
dispensed with. Microecononmics concentrates on working the individual components
macroeconomics studies the economy in general. While the former is concerned with structures
of the aggregates, the latter is concerned with the aggregates themselves. So,both theapproaches
are supplementary to each other. The superiority of one approach over the other cannot be claimed.
Need for a Separate Theory of Macroeconomics
Microeconomics failed to study the aggregates of the economy as a whole. As a result, there was
a need for a separate theory, which could explain the working of the economy. Macroeconomics

helps to understand the working ofan economic system as well as to explain the various macroeconomic
paradoxes.
1.7 ENTRAL PROBLEMS OF AN ECONOMY
Production, distribution and disposition of goods and services are the basic economic activities
of life. In the course of these activities, every society has to face scarcity of resources. Because of
this scarcity, every society has to decide how to allocate the scarce resources. It leads to following
Central Problems, that are faced by every economy:
1. What to produce
2. How to produce
3 For whom toproduce
These problems are called central problems because these are the most basic problems ofan economy and
all other problems revolve around them.
These 3problems are studied under the problem of Allocation of Resources'.
 1.8
Introductory Microeconomics
Aotation of Resources (Studied under Microeconomics)
Allocation of resources refers to the problem of assigning the scarce resources in such a manner so that
maximum wants of the society are
fulfilled. As resources are limited in relation to the unlimited
wants, it is important to economize their use and utilize them in the
most efficient manner.
The problem of allocation of resources is studied under 3 heads: (1) What to
to produce; (3) For whom to produce; (2) How
produce.
Innutshel, an economy has to allocate its resources and choose from different
goods (What to produce), select from different techniques of production (How to potentialand decide
bundles of
in the end, who will consume produce),
the goods (For whom to produce).

What to Produce
This problem involves selection
of goods and services to be produced and the quantity to be
produced of each selected commodity. Every economy has limited resources and
thus, cannot
produce all the goods. More of one good or service usually means less of others.
For example.
production of more sugar is possible only by reducing the production of other
Production of more war goods is goods.
possible
the basis of the importance of various
only by reducing the production of civil
goods. So, on
goods, an
economy has to decide which
produced and in what quantities. This is a problem of allocation of resources amonggoods
should be
different goods.
The problem of 'What to
produce' two aspects:
has
(Jhat possible commodities produce: An economy has to decide, which consumer goods
to
(rice, wheat, clothes, etc.) and which of the capital goods
are to be
(machinery, equipments, etc.)
produced. In the same way, economy has to make a choice between civil goods
(bread butter, etc.) and war goods (guns, tanks, etc.).
ii
How much to produce: After
deciding the goods to be produced, economy has to decide
the quantity of each
commodity, that is selected. It means, it involves a decision regarding
the quantity to be produced, consumer and
of capital goods, civil and war goods and so on.
As this problem has two aspects, it is also termed as "What to Produce and in what Quantity".
Guiding Principle of What to Produce': Allocate the resources in a manner which
aggregate satisfaction.
gives maximum

2 to Produce
his problem refers to selection of technique to be used for production of goods and services. A
good can be produced using different techniques of production. By 'technique', we mean which
particular combination of inputs to be used. Generally, techniques are classified as: Labour
intensive techniques (LIT) and Capital intensive techniques (CIT).
An Labour intensive technique, more labour and less capital (in the form of machines, etc.)
is used.
Capital intensive technique, there is more capital and less labour utilization.
Forexample, textles can be produced either with a lot of labour and a litle capital or with less labour
and more capital. Availability of factors and their relative prices helps in determining the technique to
be used.
 1.9
Introduction
of the standard of
The selection of technique is made with a view to achieve the objective raising
in India, LIT is preferred
living of people and to provide employment everyone. For example,
to
etc. prefer CIT due to
due to abundance of labour, whereas, countries like U.S.A., England,
shortage of labour and abundance of capital.
in such a manner so that
Guiding Principle of 'How to Produce: Combine factors of production resources.
maximum output is produced at minimum cost, using least possible scarce

3. For Whom to Produce

the individuals
This problem relates to the distribution of produced goods and services among
consunme the
within the economy, i.e. selection of the category of people who will ultimately
less rich or more rich and less poor.
goods, i.e. whether to produce goods for more poor and
Since resources are scarce in every economy, no society can satisfy all the wants of its people.
who have the paying
Thus, aproblem of choice arises. Goods are produced for those people
their level of income. It means,
capacity. The capacity of people to pay for goods depends upon
this problem is concerned with distribution of income among the factors of production
(land, labour,

capital and enterprise), who contribute in the production process.

The problem can be categorised under two main heads:
national income of an economy is distributed among
(i) Personal Distribution: It means how
different groups of people.
deciding the share of different factors of production
(ii) Functional Distribution: It involves
in the total national product of the country.

to Produce: Ensure that urgent wants of each productive factor are

Guiding Principle of For whom
fulfilled to the maximum possible extent.

there are two more Central Problems:

It must be noted that in addition to Allocation of Resources',
of
i) Problem of fuller and efficient utilsation resources; (i) Problem of Growth of resources. However,
of XIh class.
they are beyond the scope of syllabus

. 8 OPPÓRTUNITY COST
is forced to make choices. To produce more of one
Asresources are scarce, the society always
has to be sacrificed. The true cost of using economic
good, a certain amount of other goods alternative
is the loSs of the output which they might have
resources in any given project
produced.
and capital to build a factory, then the economic
For example, if we use a certain amount of land, labour
houses which these resources could have produced
Cost (or opportunity cost) of the factory might be the

Hence, OPportunity Cost is the cost of nert best alternative foregone. For example, Suppose,
receive
Further suppose, you
you are working in a bank at the salary of R 40,000 per month.
two more job offers:
T o work as an executive at 7 30,000 per month; or

To become a journalist at ? 35,000 per month.

 1.10 Introductory Microeconomics

In the given case, the opportunity cost of working in the bank is the cost of next best alternative
foregone, i.e. T 35,000. The amount of other goods and services, that nmust be sacrificed to obtain more
of any one good, is called the opportunity cost of that good.
One more Example
Suppose you have R 20,000 and you want to purchase one laptop and a LED TV. With 20,000
only in hand, you cannot have both. You can either buy laptop or LED TV. If you decide
to then opportunity cost of choosing the laptop is the cost of the foregone
purchase laptop,
satisfaction (from LED TV). This example clearly demonstrates a fundamental economic condition:
As ourresourcesare limited, we are atways forced to make choices betwen alternate commodities'.

1.9 PRObUCTION POSSIBILITY FRONTIER (PPF)

Due to scarcity of resources, we cannot satisfy all our wants. Even if an economy uses all its
resources in the best possible manner, its capabilities are restricted due to scarcity of resources.
As we cannot have everything that we want, we are forced to make economic
decisions. These
decisions take the form of choices among alternate
goods and services, that will best satisfy
our wants. Thus, the
society must decide, what to produce out of an
almost infinite range of possibilities.
As the choice is to be made between infinite
possibilities, the economists assumed a
very basic
economy with only two goods (say, guns and butter). Economists have traditionally represented
this range of choicesby what they call a 'Production Possibility Schedule' (Table 1.1). When this
schedule is graphically represented (Fig. 1.1), it is called Production
Production Possibility Curve (PPC).
Possibility Frontier (PPF)' or
Production Possibility Frontier (PPF) refers to
graphical representation ofpossible combinations
of two goods that can be produced with given resources and technology.
the locus of various possible combinations two Alternately, PPF is
of goods that can be produced with given resources and
technology
Only 2 Goods are taken: The two goods have been taken just for the sake of simplicity and
easy
understanding. However, the analysis involved can be applied equally well, to any combination
of goods.
Synonyms of PPF
PPF is also known by the following names:
Production Possibility Curve Production Possibility Boundary
Transformation Curve .Transformation Boundary
Transformation Frontier

Assumptions for PPF

Production possibility frontier is based on the
following assumptions:
1. The amount of resources in an economy is fixed, but these resources can be transferred
from one use to another;
2. With the help of
given resources, only two goods can be produced;
3. The resources are
fully and efficiently utilised;
Introduction
1.11
4. Resources are not equally efficient in production of all products. So, when resources are
transferred from production of one good to another, the productivity decreases;
5. The level of technology is assumed to be constant.
The concept of PPF can be better understood with the help of following imaginary (hypothetical)
schedule and diagram:
MOC A-B
Te 1.1: Production Possibility Schedule

MRT
A Gunss
Possibilities Guns (in units) Butter(in units) MOC
A Butter

A 21 0

B 20 1 1G:1B

C 18 2 2 2G:1B

D 15 3 3 3G:1B

E 11 4 4 4G:1B

F 6 5 5G:1B

G 6 6 6G:1B

Table 1.1 shows the various possibilities of guns and butter. This data is graphically represented
in Fig. 1.1,
PPF of Guns and Butter
If the economy uses all its resources to produce only
and no
guns, then maximum of 21 units of guns
butter can be produced (point 'A').
18
On the other hand, if all resources are used for butter,
5
then maximum 6 units of butter and no guns can be
12
produced (point 'G').
Inbetween, there are various possibilities with
different combinations of guns and butter.
When points A, B, C, D, E, F and G are joined, we get
a curve AG, known as Production Possibility Frontier'. OI
AG curve shows the maximum limit of production Butter (in units)
Fig. 1.1
of guns and butter.
Arginal Opportunity Cost (MOC)
MOC refers to the number of units of a commodity sacrificed to gain one additional unit of another
commodity) In case of PPF, MOC is always increasing, i.e. more and more units.ofacommodity
have to besacrificedto gain anadditional unit of another.commodity.
1.12
IntroductoryMicroeconomics
Why Increasing MOC operates?
Increasing MOC operates because productivity and efficiency of factors of production
decrease.as they are shiftadfrom.one use to another. Let us understand this with the help
of an example: Suppose an economy produces only two goods (say, guns and butter).
A Worker is
employed in production of guns because he is best suited for it. Iif economy
decides to reduce production of guns and increase production of butter, then worker will be
transferred to production of butter. However, he is not that efficient in production of butter
as he was in guns. As a result, his productivity in butter will be low and MOC will increase.

i n a l Rate of Transformation (MRT)

MRT is the ratio of
number of units of a commodity sacrificed to gain an additional unit of another
CommodityMRT=4 Units Sacrificed
I n the given example of guns and butter, MRT= A Guns
A Units Gained
A Butter
Example of MRT
According to Table 1.1, 20 units of guns and 1 unit of butter (i.e. 20G+1B) can be
by utilising the resources fully and efficiently. If the economy decides to produced
has to cut down produce 2B, then it
production of guns by 2 units. In the given case, 2G is the opportunity cost of
producing 1B, ie. MRT is 2G:1B.

Caracteristics or Properties of PPF

The two basic characteristics or features or
properties of PPF are:
PPF slopes Downwards: PPF shows all the maximum possible combination of
which canbeproduced with the available resources and two goods,
good can be produced auly by taking.resources awayfromthetechnology.
In sucha case, more of one
exists an inverse relationship between production of.another goods As there
in quantity
change in quantity of one
commodity and change
of the other commodity, PPF slopes downwards from left to right (see
Fig. 1.1).
TPE is Concave Shaped:PE is concave shaped because of increasing marginal rate
transformation(MRT), 1.e. more gnd more units of one commodity are sacrificed to gain an additionalof
unit of another commodity.
MRT increases because it is assumed that no resource is
of all goods As resources are transferred from one equally efficient in production
good to another, less and less efficient
resources have to be
employed. This raises cost and raises MRT. In the given example of
guns and butter, units of guns sacrificed keep on
of one unit of butter.
increasing each time to increase production

Whether Economy will

always operate on PPF?
It must be remembered that PPF does not show
the point at which the
economy will actually
operate. It only shows the maximum available possibilities, which an
The exact point of economy can produce.
operation depends on how well the resources of the economy are used.
1. Economy will
operate on PPF only when resources are fully and efficiently utilised.
2. Economy will
operate at any point inside PPF if resources are not fully and utilised.
efficiently
Introduction 1.13
3. Economy cannot operate at any point outside PPF as it is unattainable with the available

productive capacity.
It means:
Economy can either operate on PPF or inside PPE, known as 'Attainable Combinations'
But, economy cannot operate outside PPF, known as 'Unattainable Combinations'.

Attainable and Unattainable Combinations

Let us clear the concept of 'Attainable and Unattainable Combinations' with the help of Fig. 1.2

21 F
Any point on PPF (Points A to D) or
18 any point inside PPC (Point E) are
attainable combinations
Any point outside PPF (point F) is
12 an unattainable combination.

D
E

X
O
Butter (in units)
Fig. 1.2

Attainable Combinations: It refers to those combinations at which economy can operate. There
can be two attainable options:
1. Optimum utilisation of resources: If the resources are used in the best possible manner, then

economy will operate at any point (like, A, B, C or D) on PPF.

2. Inefficient utilisation of resources: Howeve, the actual PPF and MRT

production can fall short of its capabilities. If there 21

is wastage or inefficient utilisation of resources, then
18
economy will operate at any point inside the PPF (like E).
Unattainable Combinations: With the given amount of
available resources, it is impossible for the economy to 2
produce any combination more than the given possible
combinations i.e. an economy can never operate at any point 65
outside the PPF (like F).
For An economy always produces on, but not inside, a PPF" X
refer HOTS. Butter (in units)
Fig.1.3
1.14 Introductory Microeconomics
PPF and MRT
We can measure MRT on the PPF. For example, MRT between the possibilities D and E is equal
to DH/HE and between E and F, it is equal to EI/IF and so on.
We know, PPF is concave shaped curve. The slope of PPF is a measure of the MRT. Since the
slope of a concave curve increases as we move downwards along the curve, the MRT also rises
as we move downwards along the curve.

Can PPF be a straight line?

PPF can be a straight line if we assume that MRT is constant, i.e. same amount of a
commodity is
sacrificed to gain an additional unit of another commodity. It is possible only when we assume
that all the resources are equally efficient in
production of all goods. In such case, PPF will be
a straight line as shown in Fig. 1.4.

GoodYA Good Y A

B
>X
Fig. 1.4 Good X
Good Ol
Good X
Fig. 1.5
Can PPF be Convex to the Origin?
PPF can be convex to the origin if MRT is
decreasing, i.e. less and less units of a commodity are
sacrificed to gain an additional unit of another
commodity. In such case, PPF will be a convex
shaped curve as shown in Fig. 1.5.
t must be noted that both these situations
(i.e. PPF being a straight line or convex
shaped) would not
arise, as MAT always increases. So, PPF is ahways concave shaped.

PPF and Opportunity Cost

The opportunity cost of a product is the alternative that PPF of Opportunity Cost

must be given up to produce that product. PPF illustrates 21

the concept of opportunity cost. The opportunity cost of 18t

producing more butter is fewer guns. As we move from 'E' 15
to F" (see Fig. 1.6 and Table 1.1), the
production of butter 2
rises from 4 units to 5 units, but the number of
guns
decreases from 11 units to 6 units, i.e. 5 Guns
opportunity cost of
the 5th unit of butter is sacrifice of 5 units of
guns.
fall the resources of the economyare fully and efficienty utilised,
then more of one good can be produced only by taking resources G X
away from the production ofanothergood. The lost production 12 3 4 5
of such other good is the opportunity cost of the first. Butter (in units)
Fig. 1.6
Introduction 1.15
PPF as Transformation Curve
Slope of PPF indicates the ease or difficulty in transforming one good into another. In the
given example (Table 1.1), when we move down the curve, we transform guns into butter,
and when we move up, we transform butter into guns. Because of this reasson, PPF is known
as "Transformation Curve".

Change in PPF
PPF is based on the assumption, that resources of an economy are fixed. However, in this
changing world, the productive capacity of an economy is constantly changing due to increase
or decrease in resources. Such changes in resource lead to change in PPE. The change in PPE
indicates either an increase or a decrease in the productive capacity of the economy.
The change in PPF can be of two types:
1. Shift in PPE: PPF will shift when there is change in productive capacity (resources or
technology) with respect to both the goods.
2. Rotation of PPF: PPF will rotate when there is change in productive capacity (resources
or technology) with respect to only one good.
1. Shift in PPF Rightward Shift in PPF
The PPF can shift either towards right or
towards left, when there is change in resources
******~--. PPF shifts to the right from
or technology with respect to both the goods.
(i) Rightward Shift in PPF: When there is -----. PP to P,P, when there is
growth of resources or/and
technological upgradation of
both guns and butte.
"Adoancement or Upgradation of Technology"
or/and "Growth of Resources in respect
to both the goods, then PPF will shift to
the right. For example, if there is increase
in resources for production of butter Butter (in units)

and guns, we can produce more of both Fig.1.7

the goods. In such case, existing PPF (PP) will shift to the right, represented by P,P, in
Fig. 1.7.
"Growth of Resources" take place when:
Quantity of Resources increases, lke: () Discovery of new natural resources: (i) Infilow of
Foreign
Capital: (i) Increase in labour force.
.Quality of Resources increases, like: () "Skill Development of Human Resources" due to
establishment of Educational Institutes or schemes like Pradhan Mantri Kaushal Vikas Yojana;
() "mproved HygienicEnvironment due to 'Clean India Mission' (Swachh Bharat Mission).

(ii) Leftward Shift in PPF: PPF will shift towards left, when there is a technological
degradation and/or decrease in resources with respect to both the goods. For example,
destruction of resources in an earthquake will reduce the productive capacity and as a
result, PPF will shift to the left from PP to P,P, (Fig. 1.8).

For, How PPF will be affected by massive unemployment", refer HOTS.

1.16 Introductory Microeconomics
Leftward Shltt in PPF

PPF shifts to the left from PP to P,P

P when there is decrease in resources
or/and technological degradation of
both guns and butter.
-

X
O P
Butter (in units)
Fig.1.8
2. Rotation of PPF
It happens when there is change in productive capacity (resources or technology) with respect
to only one good. The rotation can be either for the commodity on the X-axis or for commodity
on the Y-axis.
(i) Rotation for commodity on the X-axis: When there is a technological improvement or
an increase in resources for production of the commodity on the X-axis (say, butter), then
PPF will rotate from AB to AC.
However, in case of technological degradation or decrease in resources for production
of butter, PPF will rotate to the left from AB to AD (Fig. 1.9)
Rotation for Commodity Rotation for Commodity
on the X-axis Y on the Y-axis

Rightward
rotation
C
A
.-- ****--. .

Leftward
rotation
-
---.
----.
Rightward
Leftward rotation rotation
X
B
Butter (in units) Butter (in units)
Fig. 1.9 Fig. 1.10

Cii) Rotation for commodity on the Y-axis: A technological improvement or an increase in

resources for production of commodity on Y-axis (say, guns), will rotate the PPF from
AB to CB.
However, in case of degradation in technology or a decrease in resources for production
of guns, PPF will rotate to the left from AB to DB as shown in Fig. 1.10
 Introduction
1.17
Overview of PPF
Let us quickly revise the concept of PPF with the help of Fig. 1.11:

Unattainable
Point
D

-.
Inward .
Shift . B
Outward
Shift
D
Underutilization
of resources P
X
P2
Commodity-X
Fig. 1.11

1. PPF slopes downwards, as an increase in production of one good requires decrease in

production of the other.
2. PPF is concave shaped due to increasing MRT.
3. PPF shows transformation of one good into another, not physically, but by diverting
resources from one use to the other.
4. PPF shows the maximum available possibilities. The exact point of operation depends on
how well the resources of the economy are used.
5. If the economy operates on PPF (like points A, B or C), it means resources are fully and
efficiently utilised.
6. If the economy operates at any point inside PPF (like point 'D'), it means resources are not
fully and efficiently utilised.
7. Economy cannot operate at any point outside PPF (like point 'E'), as it is unattainable with
the available productive capacity.
8. An outward shift in PPF from PP to P,P, means, that the economy can produce more of
both the commodities, which was not possible earlier.
9. An inward shift in PPF from PP to P,P2 means, that the economy's capacity to produce
both the commodities has reduced.

Reler PowerB00sterfor"SolutionofCentral Problems through PPF

1.10 SOLVED PRACTICALS

Practicals on Opportunity Cost
Example 1. Deepak is working as a sales manager at a salary of 1,00,000 per month. He received
2 more job offers. He got an offer of R 70,000 from Reliance Industry and offer of R 85,000 from
Tata Industry. What is his opportunity cost for working as a sales manager?
 Introduction 1.21

REVISION OF KEY POINTS

Economy is a system which provides people with the means to work and earm a living.
Scarcity refers to a situation in which resources are insufficient to meet all the human wants.
Economising of resources refers to making optimum use of the available resources.

Economic problem is a problem of choice involving satisfaction of unlimited wants out of limited
sesources having alternative uses.
Economics is a social science which studies the way, a society chooses to use its limited resources, which
have altemative uses, to produce goods and services and to distribute them among different groups of people.
Two branches of Economics are Microeconomics and Macroeconomics.
()Microeconomics is that part of economic theory which studies behaviour of individual units of an economy.
Gi) Macroeconomics is that part of economic theory which studies the behaviour of aggregates of the
economy as a whole.
Positive Economics deals with what are the economic problems and how are they actually solved. For
example, India is an overpopulated country or prices are constantly rising.
Normative Economics deals with what ought to be or how the economic problems should be solved.
For example, India should not be an overpopulated country or prices should not rise.
Distinction between Microeconomics and Macroeconomics
(a) Microeconomics studies the economic behaviour of individual units, whereas, macroeconomics studies
the economy as a whole.
(b) Main tools of microeconomics are demand and supply, whereas, main tools of macroeconomics are
aggregate demand and aggregate supply.
(c) Basic objective of microeconomics is price determination, whereas, basic objective of macroeconomics
is determination of equilibrium level of income and employment.
(d) The aggregates of microeconomics have limited degree of aggregation as compared to aggregates of
macroeconomics.

Major eéntral Problems are:

W h a t to produce: It refers to selection of goods and services and quantity to be produced of each
selected commodity.
(i) How to produce: lt deals with the selection of technique, i.e. to use labour intensive or capital intensive
technique for the production of goods and services.
(i) For whom to produce: This problem relates to the distribution of produced goods and services among
the individuals within the economy
Opportunity Cost is the cost of the next best alternative foregone.
Production possibility frontier (PPF) refers to a graphical representation of all the possible
Xcombinations of two goods that can be produced with the given resources and technology.
() PPF slopes downwards as more of one good can be produced only by taking resources away from
the production of another good.
(i) PPF is concave shaped because of increasing marginal rate of transformation (MRT), i.e. more and
more units of one commodity are sacrificed to gain an additional unit of another commodity.
(i) All Points inside PPFare inefficient. Points on the curve are efficient. Points outside the curve are impossible.
(v Rotation of PPF occurs when there is a change in technology or resources for one commodity only.
()Shift in PPF occurs when there is a change in technology or resources for both the goods. PPF shifts
towards right in case of an increase in resources or technological upgradation. PPF shifts towards left
when there is a decrease in resources or technological degradation.
1.22
Introductory Microeconomics

Synonyms or Similar Terms of this Chapter

Positive Economics Positive Science
Normative Economics Normative Science
Microeconomics Price Theory
Macroeconomics Income and Employment Theory
Production Possibility Frontier (PPF) Production Possibility Curve (PPC)
.Production Possibility Boundary
Transformation Curve
Transformation Boundary
Transformation Frontier
 1.39
Introduction

POWER BOOSTER
ECONOMY
1. MARKET ECONOMY AND CENTRALLY PLANNED
be broadly classified as:
On the basis of nature of economic activities, economies can
1. Market Economy 2. Centrally Planned Economy

Market EConomy
in which the means ofproduction are owned,
controlled operated
and
Market Economy is the one

by the private sector. This economy is also known Capitalist Economy.

as

In this kind of economy, production is done mainly for earning profits.

So, central problems are
of demand and supply. The price,
solved by Price Mechanism, which works through the forces
are equal to each other, is
determined as
at which both demand and supply of a commodity
the equilibrium price in the market.
Features of Market Economy
follows:
The important features of market economy are as

means of production (i.e., land, labour,

1. Private ownership over means of production: All the
sector.
capital and enterprise) are owned and managed by private
sector is free to take all decisions regarding production,
2. Independent decision-making: Private
consumption and investment independently.
different private firms.
3. Level of Competition: There exists stiff competition among
the profit motive.
4. Profit Motive: All the decisions are generally guided by
does not interfere in any economic activity.
5. Non-interference ofgovernment: The government
mechanism.
A market economy works through price
6. Price Mechanism guides all decisions:
determined by market forces of demand and supply. It helps
It is a process where price is
how and for whom to produce) of economy.
in solving central problems (i.e. what,

Centrally Planned Economy

are owned,
to an economy in which means of production
Centrally Planned Economy refers
This economy is also known as Socialist Economy.
controlled and operated by the governmnent.
the
activities and distributes various goods among
The government organises all economic
the basic problems are solved by
consumers on the basis of its own decisions. In this economy,
known as Planning Commission). The basic aim, while
Central Planning Authority (generally
work for social welfare of people.
solving central problems, is to
Features of Centrally Planned Economy
are:
The important features of centrally planned economy
the means of production are owned by the
1. State ownership over means of production: All
government.
1.40 Introductory MicroGconom
2. Decision-making by gøvernment:Government takes all the decision regarding consumption,
production and investment.
3. LevelofCompetition: There does not exist any element of competition under centrally planned

economy.
4. Social welfare motive: All decisions aim to maximize social welfare.
5. Planning Mechanism guides all decisions: All the decisions are taken and coordinated by
the central planning authority. The central planning authority decides what, how and
for whom to produce. Production, allocation and distribution of resources take place through
planning. There is no role for market or price mechanism.

Market Economy Vs Centrally Planned Economy

Basis Market Economy Centrally Planned Economy
Meaning It refers to an economy in which the It refers to an economy in which the
means of production are owned, con- means of production are owned,
trolled and operated by the private controlled and operated by the
sector. government.
Ownership All the means of production (land, Means of production are owned by the
labour, capital and enterprise) are government in case ofcentrally planned
private property. economy.
Decision Decisions regarding production, Decision making is done by the
Making consumption and investment are made government only.
independently in the market economy.
Competition There exists stiff competition among There does not exist any element of
the firms competition under centrally planned
economy.
Role of Government does not play any role. Government plays the complete role.
Government
Problem Central problems (what, how, for whom Central problems are solved by Central
solving to produce) are solved through Price Planning Authority.
Mechanism.

Mixed Economy
There is one more type of economy, known as 'Mixed Economy'. Mixed Economy refers
to a system in which public and private sector are alotted their respective roles for solving
the central problems of the economy together.
t combines the features of both centrally planned and market economy.
In this economy, private sector is given the freedom to choose its lines of production and
fix prices on the basis of price mechanism. At the same time, the government keeps a
close watch on its activities.
In the present moden world, no economy is 100% centrally planned or market oriented
as both the sectors play more or less equal roles in the functioning of the economy. So,
modern economies are virtually mixed economies in which central problems are solved
partly through central planning and partily through price mechanism.
Introduction 1.41

2. PPF AND CENTRAL PROBLEMS

Production possibility curve (PPF) is an important tool of Modern Economics. It can be used
to explain the various central problems of an economy.
What to Produce
This problem involves selection between different
combinations of commodities, that can be produced with 21
the help of available resources. This problem can be easily
18
explained with the help of PPF.
In Fig. 1.15, ifthe economy is operating at point 'B', then 20
12
units of guns and 1 unit of butter is produced. On the other
hand, if the economy is operating at point 'C, then 18 units
of guns and 2 units of butter are produced. Thus, different
points of PPF show different ways of allocation of resources,
between the two goods to be produced. The point, at which X
Ol
the economy will operate, depends upon the demand of Butter (in units)
consumer for various goods. Fig. 1.15

How to Produce
This problem is related to technique to be used in production of goods and services. PPF helps
in explaining, whether the technology used is efficient or not. All the points on PPF (Fig. 1.16) imply
that the most efficient technology is used. As seen in the given diagram, point H show use of
inefficient technique of production, whereas points A to G shows use of efficient techniques
of production.

Points A to G shows use

of Efficient Technology

Point H shows
inefficient use
of technology
H G X
Commodity X
Fig. 1.16

For Whom to Produce

This problem basically involves determination of distribution of national product. PPF only
8tves a rough idea about distribution ofnational product. We may construct a PlPE with luxuries c
one axis and necessities on the other axis
1.42 Introductory Microeconomics
Y

X
Necessity goods (in units)
Fig.1.17

As seen in Fig. 1.17, necessities are taken on the X-axis and luxuries on the Y-axis. Point A
shows that more luxuries are produced and there exist considerable inequalities of income in
the economy. However, point B shows that more necessities are produced and there is relatively
almost equal distribution of income in the economy.