Semester: II

Course Title: Business Economics Course Code: 21COM2T422

Unit 1: Fundamentals of Economics, Principles of Economics: Meaning, scope, importance &

limitations-The Economic Problem-Scarcity and Choice; Nature and Scope- Positive and,
Normative Economics, Micro and Macro Economics; Central Problems of an, Economy;
Production Possibility Curve; Opportunity Cost

Fundamentals of Economics
Introduction:
Business Economics is playing an important role in our daily economic life and
business practices. In actual practice different types of business are existing and run by
people so study of Business Economics becomes very useful for businessmen. Since the
emergence of economic reforms in Indian economy the whole economic scenario regarding
the business is changed.
Various new types of businesses are emerged, while taking the business decisions
businessmen are using economic tools. Economic theories, economic principles, economic
laws, equations economic concepts are used for decision making. On this ground students of
commerce should know the importance of basic theories in actual business application.
Hence the introduction of Business Economics becomes important to the students.
In 1951 Joel Dean published a book entitled "Business Economics." The the subject
Business Economics has gained popularity. Business Economics reveals that how economic
analysis is used to formulate the economic policies in respect to the business firms.
 Principles of Economics
Introduction:
Managerial Economics is both conceptual and metrical. Before the substantive decision
problems which fall within the purview of managerial economics are discussed, it is useful to
identify and understand some of the basic concepts underlying the subject. The contribution
of economics to business economics lies in certain principles which are basic to economics.
There are six basic principles of managerial economics. They are:

1. The Incremental Concept

2. The Concept of Time Perspective
3. The Opportunity Cost Concept
4. The Discounting Concept
5. The Equi-marginal Concept
6. Risk and Uncertainty

1. The Incremental Concept:

Incremental concept is closely related to the marginal cost and marginal revenues of
economic theory. The two major concepts in this analysis are incremental cost and
incremental revenue. Incremental cost denotes change in total cost, whereas incremental
revenue means change in total revenue resulting from a decision of the firm.

A decision is clearly a profitable one if

(i) It increases revenue more than costs.
(ii) It decreases some cost to a greater extent than it increases others.
(iii) It increases some revenues more than it decreases others.
(iv) It reduces costs more than revenues.

2. Concept of Time Perspective:

The time perspective concept states that the decision maker must give due consideration both
to the short run and long run effects of his decisions. He must give due emphasis to the
various time periods. It was Marshall who introduced time element in economic theory.
The economic concepts of the long run and the short run have become part of everyday
language. Business economists are also concerned with the short run and long run effects of
decisions on revenues as well as costs. The main problem in decision making is to establish
the right balance between long run and short run.
3. The Opportunity Cost Concept:
Opportunity cost, therefore, represents the benefits or revenue forgone by pursuing one
course of action rather than another. Both micro and macroeconomics make abundant use of
the fundamental concept of opportunity cost. In everyday life, we apply the notion of
opportunity cost even if we are unable to articulate its significance. In Managerial
Economics, the opportunity cost concept is useful in decision involving a choice between
different alternative courses of action.

4. Equi-Marginal Concept:
One of the widest known principles of economics is the equi-marginal principle. The
principle states that an input should be allocated so that value added by the last unit is the
same in all cases. This generalisation is popularly called the equi-marginal.
Let us assume a case in which the firm has 100 unit of labour at its disposal. And the firm is
involved in five activities viz., А, В, C, D and E. The firm can increase any one of these
activities by employing more labour but only at the cost i.e., sacrifice of other activities.

5. Discounting Concept:
This concept is an extension of the concept of time perspective. Since future is unknown and
incalculable, there is lot of risk and uncertainty in future. Everyone knows that a rupee today
is worth more than a rupee will be two years from now. The concept of discounting is found
most useful in business economics in decision problems pertaining to investment planning or
capital budgeting.
The formula of computing the present value is given below:
V = A/1+I where:
V = Present value
A = Amount invested
i = Rate of interest

6. Risk and Uncertainty:

Managerial decisions are actions of today which bear fruits in future which is unforeseen.
Future is uncertain and involves risk. The uncertainty is due to unpredictable changes in the
business cycle, structure of the economy and government policies.
This means that the management must assume the risk of making decisions for their
institution in uncertain and unknown economic conditions in the future. Firms may be
uncertain about production, market prices, strategies of rivals, etc. Under uncertainty, the
consequences of an action are not known immediately for certain.

Conclusion: The managerial economists have tried to take account of uncertainty with the
help of subjective probability. The probabilistic treatment of uncertainty requires formulation
of definite subjective expectations about cost, revenue and the environment. The probabilities
of future events are influenced by the time horizon, the risk attitude and the rate of change of
the environment.

Meaning Business Economics

Different philosophers have defined business economics or Business economics differently.

The following are some popular definitions of business economics:

According to 'McNair and Meriam' defined it as "Business Economics consists of the use of
Economic modes of thought to analyse business situations."

According to Mansfield, “Business economics is concerned with the application of economic

concepts and economics to the problems of formulating rational decision making”

In the words of Spencer and Seigelman, “Business Economics isthe integration of economic
theory with business practice for the purpose of facilitating decision making and forward
planning by management.”

According to Douglas, “Business economics is concerned with the application of economic

principles and methodologies to the decision making process within the firm or organization.
It seeks to establish rules and principles to facilitate the attainment of the desired economic
goals of management”.

According to Davis and Chang, “Business economics applies the principles and methods of
economics to analyze problems faced by management of a business, or other types of
organizations and to help find solutions that advance the best interests of such organization.”
 From the aforementioned definitions, it can be concluded that Business economics is
a link between two disciplines, which are management and economics. The management
discipline focuses on a number of principles that aid the decision-making process of
organisations.

On the other hand, economics is related to an optimum allocation of limited resources

for attaining the set objectives of organisations. Therefore, it can be said that Business
economics is a special discipline of economics that can be applied in business decision
making of organisations.

Scope of Business Economics

Business Economics covers two different categories, macroeconomics and microeconomics.

Both the sectors cover different parts of the business economics as:
 Microeconomics applies to internal or operational issues that arise within the
organization and fall under the purview of management.
 Macroeconomics focuses on external or environmental issues that influence the
functioning and performance of the business

Importance of Business Economics

1. Business decision making in real life: Business economics is concerned with those
aspects of traditional economics which are relevant for business decision making in
real life. These are adapted or modified with a view to enable the manager take better
decisions. Thus, business economic accomplishes the objective of building a suitable
tool kit from traditional economics.
2. Useful other disciplines: It also incorporates useful ideas from other disciplines such
as psychology, sociology, etc. If they are found relevant to decision making. In fact,
business economics takes the help of other disciplines having a bearing on the
business decisions in relation various explicit and implicit constraints subject to which
resource allocation is to be optimized.
3. Competent model builder: Business economics makes a manager a more competent
model builder. It helps him appreciate the essential relationship characterising a given
situation.
 4. Integrating agent: At the level of the firm. Where its operations are conducted
though known focus functional areas, such as finance, marketing, personnel and
production, business economics serves as an integrating agent by coordinating the
activities in these different areas.
5. Cognizance: Business economics takes cognizance of the interaction between the
firm and society, and accomplishes the key role of an agent in achieving the social
and economic welfare goals.

Limitations of Managerial Economics

1. Unpredictable
Because economic activities are based on human behaviours, it is prone to errors. The
combined process of producing, distributing and consuming goods and the rendering of
services is connected to human activities which could sometimes be unpredictable.

2. Non-replicable
Most times predicting market behaviours is not easy. That’s why using the same method over
and over again would not work as there is no specific solution that could meet up with what
earlier happened in the market.

3. No Unified Solution
In trying to address an economic situation in the country, different economic managers will
be tasked with coming up with the solutions. Even when they work together, they can hardly
come up with the same conclusions. So their predictions about how the market will react to
the problems may not work as expected.

4. Open to Political Manipulation

Political economists are among many people given to criticism of the process of decision
making. Using normative economics, politicians often call for changes in policies which if
closely looked at, are for their gain.

5. Inaccurate Conclusion
Most theories often put forward by economic experts to forecast future policies that
sometimes contradict one another.
 The Economic Problem

All societies face the economic problem, which is the problem of how to make the best use of
limited, or scarce, resources. The economic problem exists because, although the needs and
wants of people are endless, the resources available to satisfy needs and wants are limited.

The basic problem of an economy deals with the needs and wants of a man being unlimited
and the resources are scarce. The resources include the factors of production that are land,
labour, capital and entrepreneurship.

Economics is the social science that studies how people use their scarce resources to satisfy
unlimited needs and wants. From a teenager to a homemaker and then to a businessman all
face the same issue of how to spend their income to attain maximum satisfaction.
 Scarcity

The purpose of production is to satisfy one’s want but as the resources are limited, not
enough output is available to fulfil every man’s want. This explains that human wants are
unlimited which are not fulfilled by the limited resources as stated by the Law of scarcity.

The demand is high as compared to the supply, and due to insufficient resources satisfaction
is not achieved. To overcome this, the choice is made available to man to allocate their
resources in such a way that maximum satisfaction can be achieved.

Choices
Scarcity gives rise to the economic problem of choice. As there are limited resources, the
choice is given to decide what one wishes to get by sacrificing one of its demand. When the
choice is made there is sacrifice involved in it. The decision to consume a product also means
a decision to not consume another. One product can only be consumed by giving up
something in exchange. Opportunity Cost refers to the cost of sacrifice that is done to choose
the next best alternative.
Opportunity cost are two fundamental concepts in economics. Given that resources are
limited, producers and consumers have to make choices between competing alternatives.

Nature of Business Economics

Business Economics is a Science: Science is a systematized body of knowledge which

establishes cause and effect relationships. Business Economics integrates the tools of decision
sciences such as Mathematics, Statistics and Econometrics with Economic Theory to arrive at
appropriate strategies for achieving the goals of the business enterprises. It follows scientific
methods and empirically tests the validity of the results.

Based on Micro Economics: Business Economics is based largely on Microeconomics. A

business manager is usually concerned about achievement of the predetermined objectives of
his organisation so as to ensure the long-term survival and profitable functioning of the
organization. Since Business Economics is concerned more with the decision making
problems of individual establishments, it relies heavily on the techniques of Microeconomics.

Incorporates elements of Macro Analysis: A business unit does not operate in a vacuum. It is
affected by the external environment of the economy in which it operates such as, the general
price level, income and employment levels in the economy and government policies with
respect to taxation, interest rates, exchange rates, industries, prices, distribution, wages and
regulation of monopolies. All these are components of Macroeconomics. A business manager
must be acquainted with these and other macroeconomic variables, present as well as future,
which may influence his business environment.

Business Economics is an art: it involves practical application of rules and principles for the
attainment of set objectives.

Use of Theory of Markets and Private Enterprises: Business Economics largely uses the
theory of markets and private enterprise. It uses the theory of the firm and resource allocation
in the backdrop of a private enterprise economy.

Pragmatic in Approach: Microeconomics is abstract and purely theoretical and analyses

economic phenomena under unrealistic assumptions. In contrast, Business Economics is
pragmatic in its approach as it tackles practical problems which the firms face in the real
world.

Interdisciplinary in nature: Business Economics is interdisciplinary in nature as it

incorporates tools from other disciplines such as Mathematics, Operations Research,
Management Theory, Accounting, and marketing, Finance, Statistics and Econometrics.
Normative in Nature: Economic theory has developed along two lines – positive and
normative. A positive or pure science analyses cause and effect relationship between
variables in an objective and scientific manner, but it does not involve any value judgement.
As against this, a normative science involves value judgement. It is prescriptive in nature and
suggests ‘what should be’ a particular course of action under given circumstances. Welfare
considerations are embedded in normative science.

Scope of Business Economics

Introduction: As regards the scope of business economics, no uniformity of views exists

among various authors. However, the following aspects are said to generally fall under
business economics. Demand Analysis and

Scope of Business Economics

Forecasting

Cost and production

1. Demand Analysis and Forecasting Analysis

2. Cost and production Analysis. Pricing Decisions,

policies and practices
3. Pricing Decisions, policies and practices.
4. Profit Management. Profit Management

5. Capital Management.
Capital Management

These various aspects are also considered to be comprising the subject matter of business
economic.

1. Demand Analysis and Forecasting: A business firm is an economic organisation which

transform productive resources into goods to be sold in the market. A major part of business
decision making depends on accurate estimates of demand. A demand forecast can serve as a
guide to management for maintaining and strengthening market position and enlarging
profits. Demands analysis helps identify the various factors influencing the product demand
and thus provides guidelines for manipulating demand.

Demand analysis and forecasting provided the essential basis for business planning and
occupies a strategic place in Business economic. The main topics covered are: Demand
Determinants, Demand Distinctions and Demand Forecasting.

2. Cost and Production Analysis: A study of economic costs, combined with the data drawn
from the firm’s accounting records, can yield significant cost estimates which are useful for
management decisions. An element of cost uncertainty exists because all the factors
determining costs are not known and controllable. Discovering economic costs and the ability
to measure them are the necessary steps for more effective profit planning, cost control and
sound pricing practices.

Production analysis is narrower, in scope than cost analysis. Production analysis frequently
proceeds in physical terms while cost analysis proceeds in monetary terms. The main topics
covered under cost and production analysis are: Cost concepts and classification, Cost-output
Relationships, Economics and Dis-economics of scale, Production function and Cost control.

3. Pricing Decisions, Policies and Practices: Pricing is an important area of business

economic. In fact, price is the genesis of a firm’s revenue and as such its success largely
depends on how correctly the pricing decisions are taken. The important aspects dealt with
under-pricing include. Price Determination in Various Market Forms, Pricing Method,
Differential Pricing, Product-line Pricing and Price Forecasting.

4. Profit Management: Business firms are generally organised for purpose of making profits
and in the long run profits earned are taken as an important measure of the firm’s success. If
knowledge about the future were perfect, profit analysis would have been a very easy task.
However, in a world of uncertainty, expectations are not always realised so that profit
planning and measurement constitute a difficult area of business economic. The important
aspects covered under this area are:

Nature and Measurement of profit, Profit policies and Technique of Profit Planning like
Break-Even Analysis.

5. Capital Management: Among the various types business problems, the most complex and
troublesome for the business manager are those relating to a firm’s capital investments.
Relatively large sums are involved and the problems are so complex that their solution
requires considerable time and labour. Often the decision involving capital management are
taken by the top management.

Briefly Capital management implies planning and control of capital expenditure. The main
topics dealt with are: Cost of capital Rate of Return and Selection of Projects.
Conclusion: The various aspects outlined above represent major uncertainties which a
business firm has to reckon with viz., demand uncertainty, cost uncertainty, price uncertainty,
profit uncertainty and capital uncertainty. We can therefore, conclude that the subject matter
of business economic consists of applying economic principles and concepts to dea1 with
various uncertainties faced by a business firm.

Positive Economics & Normative Economics

Definition of Positive Economics

Positive Economics is a branch of economics that has an objective approach, based on facts.
It analyses and explains the casual relationship between variables. It explains people about
how the economy of the country operates. Positive economics is alternatively known as pure
economics or descriptive economics.

When the scientific methods are applied to economic phenomena and scarcity related issues,
it is positive economics. Statements based on positive economics considers what’s actually
occurring in the economy. It helps the policy makers to decide whether the proposed action,
will be able to fulfil our objectives or not. In this way, they accept or reject the statements.

Definition of Normative Economics

The economics that uses value judgments, opinions, beliefs is called normative economics.
This branch of economics considers values and results in statements that state, ‘what should
be the things’. It incorporates subjective analyses and focuses on theoretical situations.

Normative Economics suggests how the economy ought to operate. It is also known as policy
economics, as it takes into account individual opinions and preferences. Hence, the
statements can neither be proven right nor wrong.

BASIS FOR
POSITIVE ECONOMICS NORMATIVE ECONOMICS
COMPARISON
A branch of economics based A branch of economics based on
Meaning on data and facts is positive values, opinions and judgement is
economics. normative economics.
Nature Descriptive Prescriptive
 Analyses cause and effect
What it does? Passes value judgement.
relationship.
Perspective Objective Subjective
Study of What actually is What ought to be
Statements can be tested using
Testing Statements cannot be tested.
scientific methods.
It clearly describes economic It provides solution for the economic
Economic issues
issue. issue, based on value.

Micro and Macro Economics

Micro Economics talks about the actions of an individual unit, i.e. an individual, firm,
household, market, industry, etc. On the other hand, the Macro Economics studies the
economy as a whole, i.e. it assesses not a single unit but the combination of all i.e. firms,
households, nation, industries, market, etc.

BASIS FOR
MICROECONOMICS MACROECONOMICS
COMPARISON
The branch of economics that The branch of economics that studies
studies the behavior of an the behavior of the whole economy,
Meaning
individual consumer, firm, family (both national and international) is
is known as Microeconomics. known as Macroeconomics.
Deals with Individual economic variables Aggregate economic variables
Business Applied to operational or internal
Environment and external issues
Application issues
Aggregate Demand and Aggregate
Tools Demand and Supply
Supply
It assumes that all macro-economic It assumes that all micro-economic
Assumption
variables are constant. variables are constant.
Theory of Product Pricing, Theory Theory of National Income, Aggregate
Concerned with of Factor Pricing, Theory of Consumption, Theory of General Price
Economic Welfare. Level, Economic Growth.
Covers various issues like demand,
Covers various issues like, national
supply, product pricing, factor
Scope income, general price level,
pricing, production, consumption,
distribution, employment, money etc.
economic welfare, etc.
Helpful in determining the prices Maintains stability in the general price
of a product along with the prices level and resolves the major problems
Importance of factors of production (land, of the economy like inflation,
labor, capital, entrepreneur etc.) deflation, reflation, unemployment and
within the economy. poverty as a whole.
Limitations It is based on unrealistic It has been analyzed that 'Fallacy of
 Composition' involves, which
assumptions, i.e. In
sometimes doesn't proves true because
microeconomics it is assumed that
it is possible that what is true for
there is a full employment in the
aggregate may not be true for
society which is not at all possible.
individuals too.

Central Problems of an Economy

The basic economic activities of life are production, distribution, and disposition of goods
and services. A society will be facing scarcity of resources during the time of fulfilment of
these activities. Scarcity is evident, due to the availability of limited resources, and human
needs having no limit. This variation between the supply and demand leads to the formation
of central problems of an economy.

The central problems of an economy revolve around the following factors:.

1. What to produce?
2. How to produce?
3. For whom to produce?

What to produce?
It is one of the central problems in an economy. It is related to the type and quantity of goods
and services that need to be produced.
Since resources are in limited quantities, producing more of one good will result in less
production of the other.

How to produce?
This aspect deals with the process or technique by which the goods and services can be
produced. Generally, there are two techniques of production:
1. Labour intensive techniques
2. Capital intensive techniques
The choice of technique for production depends on the availability of the resource in that
nation, hence resource allocation becomes a challenge.
For whom to produce?
This problem deals with determining the final consumers of the goods produced. As
resources are scarce in an economy, it becomes difficult to cater to all sections of the society.
It leads to a problem of choice in an economy as a good that may be in demand among one
section, may not be in demand for another section of the society.
Such a situation arises due to the difference in income distribution among the population,
which causes a change in buying behaviour.

The Production Possibilities Curve

Since human wants are unlimited and the means to satisfy them are limited, every society is
faced with the fundamental problem of choosing and allocating its scarce resources among
alternative uses. The production possibility curve or frontier is an analytical tool which is
used to illustrate and explain this problem of choice.

Assumptions:
(1) Only two goods X (consumer goods) and Y (capital goods) are produced in
different proportions in the economy.
(2) The same resources can be used to produce either or both of the two goods and can
be shifted freely between them.
(3) The supplies of factors are fixed. But they can be re-allocated for the production of
the two goods within limits.
(4) The production techniques are given and constant.
(5) The economy’s resources are fully employed and technically efficient.
(6) The time period is short.

Explanation:
Given these assumptions, we construct a hypothetical production possibility schedule of such
an economy in Table 5.1.

Table 5.1: Production Possibility Schedule:

Possibilities Quantity of X Quantity of Y
P 0 250
В 100 230
 С 150 200
D 200 150
P1 250 0

In this schedule, P and P1 are such possibilities in which the economy can produce either 250
units of Y or 250 units of X with given quantities of factors. But the assumption is that the
economy should produce both the goods. There are many possibilities to produce the two
goods. Such possibilities are В, С and D.

The economy can produce 100 units of X and 230 units of Y in possibility B; 150 units of X
and 200 units of Y in possibility C; and 200 units of X and 150 units of Y in possibility D.
The production possibility schedule shows that when the economy produces more units of X,
it produces less units of Y successively.

In other words, the economy withdraws the given quantities of factors from the production of
Y and uses them in producing more of X. For example, to reach the possibility С from B, the
economy produces 50 units more of X and sacrifices 30 units of Y; whereas in possibility D
for the same units of X, it sacrifices 50 units of Y.

Table 5.1 is represented diagrammatically in Figure 5.6. Units of good X are measured
horizontally and that of Y on the vertical axis. The concave curve PP 1 depicts the various
possible combinations of the two goods, P, В, C, D and P 1. This is the production possibility
curve which is also known as the transformation
curve or production possibility frontier. Each
production possibility curve is the locus of output
combinations which can be obtained from given
quantities of factors or inputs.

This curve not only shows production possibilities but

also the rate of transformation of one product into the
other when the economy moves from one possibility
point to the other. The rate of transformation on a production possibility curve increases as
we move from point В to С and to D.
The production possibility curve further shows that when the society moves from the
possibility point В to С or to D, it transfers resources from the production of good Y to the
production of good X. As put by Samuelson: “A full-employment economy must always in
producing one good be giving up something of another. Substitution is the law of life in a
full-employment economy. The production possibility frontier depicts society’s menu of
choices.” This is what McConnel calls the ‘optimum product-mix’ of a society.

Again, all possibility combinations lying on the production possibility curve (such as В, С
and D) show the combinations of the two goods that can be produced by the existing
resources and technology of the society. Such combinations are said to be “technologically
efficient”.

Any combination lying inside the production possibility curve, such as R in Figure 5.6,
implies that the society is not using its existing resources fully. Such a combination is said to
be “technologically inefficient”. Any combination lying outside the production-possibility
frontier, such as K, implies that the economy does not possess sufficient resources to produce
this combination. It is said to be “technologically infeasible or unobtainable”.

Uses or Applications of the Production Possibility Curve:

The production possibility curve is of much importance in explaining some of the basic facts
of human life like the problems of unemployment, of
technological progress, of economic growth, and of
economic efficiency.

(1) Unemployment:
If we were to relax the assumption of full employment
of resources, we can know the level of unemployment of
resources in the economy. Such a situation is depicted in
Figure 5.7 where the curve PP depicts substantial
unemployment in the economy.” It implies either idle resources or inefficient use of resources
within the economy. The economy can attain the full employment level P 1P1 by utilising its
resources fully and efficiently.
At the level of full-employment the economy can have more of capital goods at point B, or
more of consumer goods at point C, or more of both the goods at point D.

(2) Technological Progress:

Technical progress enables an economy to get more output from the same quantities of
resources.

By relaxing the assumption of given and constant

production techniques, it can be shown with the help of
the production possibility curve the increase in the
production of both the goods than before.

Suppose the economy is producing certain quantities of

consumer goods and capital goods as represented by
the production possibility curve PP0 in Figure 5.8.
Given the supplies of factors, if the productive
efficiency of the economy improves by technological progress, its production possibility
curve will throughout shift outwards to P1P1 It will lead to the production of more quantities
of both consumer and capital goods, as shown by the movement from point A on PP 0 curve to
point С on P1P1 curve.
If technical progress takes place in the production of only one of the two goods, say
consumer goods, the new production possibility curve will be PP 1 in Figure 5.9. It may be
noted that even though
technical progress is
limited to one product, it
enables the economy to
have more of both goods.
Increased productivity in
consumer goods industry
makes it possible to
increase the output of this
industry. At the same time, it releases resources which can be employed to raise the output of
capital goods. Figure 5.10 shows that technical progress brings about a greater increase in
capital goods than in consumer goods CD > AB, while a greater increase in consumer goods
than in capital goods, AB > CD.

(3) Economic Growth: By relaxing the assumptions of the fixed supply of resources and of
short period, the production possibility curve helps us in explaining how an economy grows.
The supplies of resources like land, labour, capital and
entrepreneurial ability are fixed only in the short run.
Development being a continuous and long run process,
these resources change over time and shift the production
possibility curve outwards as shown in Fig. 5.11. If the
economy is stagnant at, say point 5, economic growth
will shift it to point A on the production possibility curve
PP, and a further increase in the resources may shift the
production possibility curve towards the right to P 1P1 The
economy will produce at point C. Why point С? Because when there is economic growth, the
economy will have larger quantities of both consumer and capital goods than before.

(4) Present Goods Vs. Future Goods:

An economy that allocates more resources in the present to the production of capital goods
than to consumer goods
will have more of both
kinds of goods in the
future. It will thus
experience higher
economic growth. This is
because consumer goods
satisfy the present wants
while capital goods
satisfy future wants. Figure 5.12 shows that the outward shift of the economy’s future
production possibility curve P1P1 from point A of the present curve PP is greater when more
capital goods are produced in the future. On the other hand. Figure 5.13 shows lesser outward
shift of the present curve PP from point В to the future curve P 1P1 when less capital goods are
produced in the future.
In addition to the above, we can depict any number of different pairs of goods or services on
the production possibility curves, such as public vs private goods, agricultural vs non-
agricultural goods, consumption vs investment (or saving), etc.

(5) Economic Efficiency:

The production possibility curve is also used to explain what Prof. Dorfman calls the “three
efficiencies: (i) Efficient selection of the goods to be produced, (ii) Efficient allocation of
resources in the production of these goods and efficient choice of methods of production, (iii)
Efficient allotment of the goods produced among consumers.” These are in fact the central
problems of an economy which are related to what Samuelson calls “what, how and for
whom” to produce.

(6) Economising Resources:

The production possibility curve tells us about the basic fact of human life that the resources
available to mankind in terms of factors, goods, money or time are scarce in relation to wants,
and the solution lies in economising these resources. As aptly put by Samuelson, “Economic
scarcity refers to the basic fact of life that there exists only a finite amount of human and non-
human resources, which the best technical knowledge is capable of using to produce only a
limited maximum amount of each and every good, as shown by the Production Possibility
Frontier. And thus far, nowhere on the globe is the supply of goods so plentiful or the tastes
so limited that the average man can have more than enough of everything he might fancy.”

Opportunity Cost

When we decide to do one thing, we are deciding not to do something else. To ensure that we
make the right decisions, it is important that we consider the alternatives, particularly the best
alternative. Opportunity Cost is the cost of a decision in terms of the best alternative given up
to achieve it. F

Opportunity Cost and Consumers:

Consumers are buyers and users of goods and services. We all are consumers. The vast
majority of us cannot buy everything we like. I may, for example, have to choose which
economics dictionary to buy. I will probably consider a number of different ones, taking into
account their prices.
The choice will then tend to settle on two of them. I will select the one with the widest and
the most accurate informative coverage. The closer the two dictionaries are in quality and
price, the harder the choice will be.

Opportunity Cost and Workers:

Undertaking one job involves an opportunity cost. People employed as teachers might also be
able to work as civil servants. They need to carefully consider their preference for the jobs
available. This would be influenced by a number of factors, including the remuneration
offered, chances of promotion and the job satisfaction to be gained from each job. If the pay
of civil servants or their working conditions improve, the opportunity cost of being a teacher
will increase. It may even increase to the point where some teachers resign and become civil
servants instead.

Opportunity Cost and Producers:

Producers have to decide what to make. If a farmer uses a field to grow sugar beet, he cannot
keep cattle on that field. If a car producer uses some of his factory space and workers to
produce one model of a car, he cannot use the same space and workers to make another
model of the car at the same time.

In deciding what to produce, private sector firms will tend to choose the option which will
give them the maximum profit. They will also take into account, the demand for different
products and the cost of producing those products.

Opportunity Cost and the Government:

Government has to carefully consider, its expenditure of tax revenue on various things. If it
decides to spend more on education, the opportunity cost involved may be a reduced
expenditure on health care. It could, of course, raise tax revenue in order to spend more on
education. In this case, the opportunity cost would be put on the taxpayers. To pay higher
taxes, people may have to give up the opportunity to buy certain products or to save.