1.

1 The Economizing
Problem

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 The Economizing Problem
• The foundation of economics is the economizing
problem: society’s material wants are unlimited while
resources are limited or scarce.
• Unlimited wants (the first fundamental fact):
– Economic wants are desires of people to use goods
and services that provide utility (satisfaction).
– Goods and Services satisfy wants.
– Businesses and governments also have wants.
– Over time, wants change and multiply.

The objective of all economic activity is to fulfill wants.

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 The Economizing Problem
• Scarce resources (the second fundamental fact):
– Economic resources are limited relative to wants.
– Economic resources are sometimes called factors of
production and include four categories:
• Land
• Labour
• Capital
• Entrepreneurial ability

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 The Economizing Problem
Land
•Includes all natural resources “gifts of nature” used in
the production process such as arable land, forests, water,
minerals (copper, diamond) and oil deposits.
Capital (Capital goods or investment goods)
•All manufactured aids used in producing consumer goods
and services e.g. tools and machinery.
•Capital goods are different from consumer goods
because consumer goods satisfy wants directly while
capital goods do so indirectly by aiding in the production
of consumer goods.
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 The Economizing Problem
Labor
• Consists of the physical and mental talents of individuals
used in producing goods and services e.g. services of a
doctor, lawyer, soccer player etc.
Entrepreneurial ability
• A special kind of human resource that provides four
important functions:
i. Combines resources needed for production,
ii. Makes basic business policy decisions,
iii. Is an innovator for new products, production techniques,
organizational forms,
iv. Bears the risk of time, effort, and funds.
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 The Economizing Problem
Resource payments correspond to resource categories
a. Interest is paid for the services of capital,
b. Rent is paid for the services provided by land
c. Wages to labor resources,
d. Profits to entrepreneurs, which may be negative-that is
losses.

–Quantities of resources are limited relative to the total

amount of goods and services desired.

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 Employment and Efficiency
• Economics is a science of efficiency in the use
of scarce resources.
– Efficiency requires full employment of available
resources and full production.

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 Efficient use of resources
• Full employment
– use of all available resources
– No workers should be out of work if they are willing & able
to work.
– No capital equipment or arable land should lie idle

• Full production
– Full production means that employed resources are providing
maximum satisfaction of our economic wants.
– Underemployment occurs if this is not so.
– Full production implies productive & allocative efficiency

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 Efficient use of resources
• Allocative efficiency
– means that resources are used for producing the
combination of goods and services most wanted by
society.
– for example, producing CD’s and DVD’s instead of
long-playing records with productive resources or E-
books rather than hard copy text books.
• Productive efficiency
– means that least costly production techniques are used
to produce wanted goods and services.
• Therefore, Full production means producing the “right” goods
(allocative efficiency) in the “right” way (productive
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efficiency).
 Production Possibilities Table (PPT)
• To illustrate and clarify the economizing problem, we use
the Production Possibilities Tables (PPT) and Production
Possibilities Curves (PPC).

To keep things simple we make the following assumptions:

• Full employment & productive efficiency

– Full employment means we use all available resources
– and full production means employed resources are
providing maximum satisfaction of our economic wants.
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Production Possibilities Table (PPT)
• Two goods
– The economy is only producing two goods say food and tractors
• Fixed resources
– supplies of factors of production are fixed in quantity &
quality.
• Fixed technology
– methods used to produce output does not change
during our analysis.

Note: The last 2 assumptions means we are looking @ the

economy at a certain point in time (short run). 11
 Production Possibilities of Food &
Tractor
PPT lists the different combinations of the 2 products that
can be produced with specific resources

Production alternatives
Product A B C D E

Food (tons) 0 1 2 3 4

Tractors 100 90 70 40 0

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 Production possibility curve
• At alternative A, economy devotes all its available
resources to the production of tractors.
• At E, all resources are devoted to the production of food.
• As we move from A to E, we increase production of food at
the expense of tractors
• Plot the data on a two dimensional graph to get a
production possibilities curve. Tractors on the Y-axis and
food on the x-axis.
• A production possibilities curve is a graphical
representation of choices. It shows all the possible
combinations of tractors and food. 13
Production possibility curve

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 Production possibility curve
• Each point on the PPC represents some maximum
combination of two products that can be produced if full
employment & full production are achieved.
• At any point along the PPC we are getting the maximum
output from available resources
• Thus we say that all points on the PPC are efficient.
• Because scarcity forces the society to give up one choice for
another, the slope of the PPF will always be negative,
reflecting the concept of trade off.
• Possibility A shows that all resources are devoted to
producing machines and no resources are available to
produce food.
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 Production possibility curve
• Possibility B shows that if some of the resources are
assigned to produce 1 ton of food, the production of
tractors would be reduced to 90 machines. Why?
– Because the resources used to produce the 10 tractors were
transformed to food production.
• The pattern continues on to the possibility E, where all
resources are in the production of food and no resources
available to produce tractors. This results in 4 tons of
food and zero tractors.
• Points on the PPF represent the maximum production
(output) we can get when all resources are fully
employed.
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 Production possibility curve
Optimal or best product-mix:
1.It will be some point on the curve.
2.The exact point depends on society; this is a
normative decision.

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 Production possibility curve
• The PPF divides production space into 3 distinct areas
i. Points on the PPF (points like A, B, C, D, E).
ii. Points inside the curve (points like X).
iii. Points outside the curve (points like Y).
• Points either on or inside the frontier are attainable with
the current level of resources and technology.
– However, points inside the PPF are inefficient. Some
resources are not used or idle.
• Points outside the frontier are unattainable with the
economy's current level of resources and technology. We
need more than the available resources and technology
to reach there.
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 Trade-off
• Every choice along the PPF involves a trade-off. Changes
in production from one point on the PPF to another
involve a trade-off.
– Some of one good must be forgone (given up) to gain more
of the other good.
• On this PPF, we must give up some tractors to get more
food or give up some food to get more food.
• Therefore, a country that must decrease production of
one good in order to increase the production of another
must be producing on its PPF .
• All trade-offs involve a cost-an opportunity cost.
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 Opportunity cost
• The amount of other products that must be forgone or
sacrificed to obtain 1 unit of a specific good is called the
opportunity cost of that good.
• At point A when we use all the resources to produce tractors,
foregone food would become the opportunity cost of using all
resources to produce tractors.
• At point B, we produce 1 ton of food at the expense of not
producing 10 tractors.
• Movement from B to C involves sacrificing 20 tractors to gain 1
more ton of food.
• Each additional ton of food produced implies the loss
(opportunity cost) of tractors. Likewise, every tractor produced
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implies the loss of some food.
 Calculation of Opportunity cost
The opportunity cost of producing one more unit of a
good is the marginal cost of that good.
OC of OC of
Possibility Food Possibilities producing producing
Tractors
point (Tons) Points one unit of one unit of
Food Tractor

A 100 0 ------- ------- -------

B 90 1 A and B 10 ?
C 70 2 B and C ? ?
D 40 3 C and D 30 ?
E 0 4 D and E ? ?
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The PPC illustrates two important
principles
i. Scarce Resources: there is a limit to the amount
that we can produce in a given time period
with available resources and technology.
ii. Opportunity cost: we can obtain additional
quantities of any desired good only by
reducing the potential production of another
good.

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 Law of increasing opportunity cost
• It is difficult to move resources from one industry to
another because they are not all equally productive in all
activities.
– People have different skills and abilities, land is better suited to
some uses rather than others, and the equipment used to make
one good may not be suitable for making another good.
• Because resources are not all equally productive in all
activities, the PPF bows outward (PPF is concave).
– It shows that when the economy moves from A to E, it must
give up successfully larger amounts of tractors to acquire equal
increments of food.
• The outward bow of the PPF means that as the quantity
produced of each good increase, its opportunity cost
increases. 23
 Law of increasing opportunity
cost
• The difficulties in transferring factors of production from
one industry to another are so common that we often
speak of the law of increasing opportunity cost.
• This law says that we must give up increasing quantities of
other goods and services in order to get more of a
particular good.
– The law is not based solely on the limited use of resources in
areas other than what they are specialized in, but also the mix
of factors of production makes a difference as well.
• Note: opportunity cost are measured in real terms rather
than money ( market prices are not part of the production
possibility model). 24
 Calculation of Opportunity cost Practice
Question
• Plot the data on a two dimensional graph to get a production possibilities curve. Food
on the Y-axis and Machines on the x-axis. Calculate the opportunity cost of producing
one unit of Food. Also calcuate the opportunity cost of producing one unit of
Machines
Possibility Machines Food Possibilities OC of producing one OC of producing one
point (Per day) (Tons) Points unit of Machines (MC unit of Food (MC of
of Tractors) Food)

A 5 0 ------- ------- -------

B 4 2 A and B ? ?
C 3 3 B and C ? ?

D 2 3.8 C and D ? ?
E 1 4.5 D and E ? ?
F 0 5 E and F ? ?

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 A growing economy
• Increases in resource supplies: increase in population
increases labor supply; improved access to health care
& education improves labor quality; discovery of
minerals increases our productive land resources etc.
• The increased supplies of factors of production
enables the economy to produce more goods &
services
• This is represented by an outward shift of the PPC

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 A growing economy
• Advances in technology: Advanced technology enables
the economy to produce new & better goods & improved
ways of producing them. The economy can now produce
more goods with fixed resources.

– This too shifts the PPC outwards to the right.

– This represents growth of economic capacity or

economic growth.

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 Shift in the PPC

Tractor (Per
Year) New PPC
A1

A
B B1

C C1
Initial PPC

0
Food (tons/year)
28