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Economics Lecture 3

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Economics Lecture 3 2007 Economics Dept Mr Lim Peng Yeow Agenda Today What is the Production Possibility Curve (PPC)? - Shapes - How it illustrates the different ... – PowerPoint PPT presentation

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Title: Economics Lecture 3


1
Economics Lecture 3
  • 2007 Economics Dept
  • Mr Lim Peng Yeow

2
RECAP
Economic Problem - Scarcity
Unlimited wants
Limited resources
Choice
Opportunity Cost
3
Agenda Today
  • What is the Production Possibility Curve (PPC)?
  • - Shapes
  • - How it illustrates the different economic
    concepts
  • - Productive and allocative efficiency.
  • - Movement vs Shifts in the PPC.
  • Capital goods vs consumption goods.
  • Comparative advantage

4
Production Possibility Curve/Frontier
How to measure Opp Cost?
5
The Production Possibility Curve
  • The Production Possibility Curve (or frontier)
    shows the maximum alternative combinations of two
    goods a society can produce if all resources are
    fully and efficiently used given a fixed amount
    of inputs and level of technology.

6
What does a PPC show?
  • Purposes of model
  • Show scarcity constraint
  • Illustrate economic efficiency
  • Introduce opportunity cost concept
  • Economic Growth

7
The Production Possibility Curve
  • The production possibilities model is based on
    three assumptions
  • an economy makes only two goods
  • Resources, technology and timeline are fixed
  • all resources are employed to their fullest
    capacity

8
Case Scenario
  • A Student who can only study 2 subjects
  • Economics
  • History
  • Given Level of input 12 Hours
  • Ability to study both equally well given a fixed
    amount of time spent. Trade off is constant

9
Table
Time Spent (Economics) Time Spent (History) Expected Grade (economics) Expected Grade (history)
12 0 A F
9 3 B D
6 6 C C
3 9 D B
0 12 F A
10
ProductionPossibility Curve (PPC)
11
ProductionPossibility Curve (PPC)
  • Food for thought
  • What would happen to the production possibilities
    curve if you spent more time studying?
  • What would happen to the potential grades?
  • Is it possible that the trade-off might not be
    constant? What do you think is more realistic?

12
General case for a country
  • Two broadly classified goods in an economy.
  • Consumption goods
  • Capital goods
  • Consumption goods - goods produced for present
    consumption.
  • Capital goods - goods used to produce other goods
    or services over time.

13
PRODUCTION POSSIBILITY FRONTIER (PPF)
A PPF can be constructed using the table below.
Each combination shows the maximum amount of
goods that can be produced.
Combination Consumer Gds Capital Gds
A 0 50
B 10 48
C 20 45
D 30 40
E 40 33
F 50 23
G 60 0
14
PRODUCTION POSSIBILITY FRONTIER (PPF)
Capital Gds (units)
Consumer Gds (units)
15
PRODUCTION POSSIBILITY FRONTIER (PPF)
  • Observe the table again
  • As we move down the different combinations, can
    you see that to produce more of consumer goods,
    the production of the other has to be reduced?

Combination Consumer Gds Capital Gds
A 0 50
B 10 48
C 20 45
D 30 40
E 40 33
F 50 23
G 60 0
  • Because of scarcity,a country cannot produce more
    of both goods.
  • Hence the country has to make a choice between
    which combination of goods does it want to
    produce.

16
PRODUCTION POSSIBILITY FRONTIER (PPF)
o.c of producing 10 units of consumer gds A ?B
2 units of capital goods
A
B ?C 3 units of capital goods
B
50
C
D
C ?D 5 units of capital goods
40
E
D ?E 7 units of capital goods
30
E ?F 10 units of capital goods
F
F ?G 23 units of capital goods
20
G
0
10
20
30
60
40
50
17
Slope of the PPC
  • Slope of the PPC reflects the Opportunity Cost
    of producing either good.
  • Increasing Concave
  • Constant - Straight Line
  • Decreasing - Convex

Capital goods
Consumption goods
18
Efficiency in Production
  • Productive Efficiency
  • an economy is producing the maximum output with
    given technology and resources i.e. can be seen
    on PPF. Any point on the curve is productive
    efficient
  • Allocative Efficiency
  • refers to a situation whereby resources are
    allocated such that no one can be made better-off
    without another made worse-off. i.e. resources
    are allocated to maximum benefit of everyone.

19
The Production Possibility Curve
  • Points inside of the curve are inefficient.
  • At point H, resources are either unemployed, or
    are used inefficiently.

20
The Production Possibility Curve
  • Point F is desirable because it yields more of
    both goods, but it is unattainable given the
    amount of resources available in the economy.

21
The Production Possibility Curve
  • Point C is one of the possible combinations of
    goods produced when resources are fully and
    efficiently employed.

22
The Production Possibility Curve
  • A movement along the curve illustrates the
    concept of opportunity cost. How many consumer
    goods had to be given up to get 250 more capital
    goods?
  • In order to increase the production of capital
    goods, the amount of consumer goods will have to
    decrease.

23
Shifts in the PPC
  • What is the implication of a shift in the
    boundaries of the PPC?
  • Shifting Out Increase in productive capacity of
    the country
  • Shifting in Decrease in productive capacity of
    the country
  • What could be the cause of such shifts?

24
Factors that could shift the PPC
  • Increase in resources available
  • Higher Productivity of resources
  • Higher education
  • More training
  • Improvement in technology

25
Changes in productive capacity
Newer and more efficient machines are utilised
Capital Goods
Today
Outward shift indicates an increase in the
productive capacity of the country
Consumption Goods
26
Economic Growth
  • Economic growth is an increase in the total
    output of the economy. It occurs when a society
    acquires new resources, or when it learns to
    produce more using existing resources.
  • The main sources of economic growth are capital
    accumulation, education and technological
    advances.

27
Economic Growth
  • Outward shifts of the curve represent economic
    growth.
  • To increase the production of one good without
    decreasing the production of the other, the PPC
    must shift outward.
  • From point D, the economy can choose any
    combination of output between F and G.

28
Capital or consumption goods?
  • Why is there a need to choose which to produce
    and what is the significance of the choice made?
  • It will affect the future productive capacity of
    a country
  • The PPC can be used to illustrate the trade-off
    between present and future consumption.

29
Capital Goods and Growth
Increase in production capability due to increase
in capital goods
Capital Goods
Capital Goods
B
Today
A
5
4
Consumption Goods
Consumption Goods
30
Capital Goods and Growth
Decrease in production capability due to non
replacement of spoilt machinery
Today
Capital Goods
Capital Goods
B
5
Consumption Goods
Consumption Goods
31
Capital Goods and Growth
  • Observations
  • Forgo consumption goods to produce capital goods
  • Increase in capital goods stimulates economic
    growth
  • An increase in capital goods will lead to a
    higher rate of economic growth in the future
  • An decrease in capital goods will have the
    reverse effect.

32
Comparative advantage exchange
Country Y
Country X
Country X has Comparative Advantage over Country
Y in the production of Good B!
Both countries can produce 100 units of Good A if
they allocate ALL their resources in its
production. BUT Country X can produce 20 units
more of Good B compared to Country Y.
33
Summary
  • What is the PPC?
  • Explain its shape and how it illustrates the
    different economic concepts.
  • Productive and allocative efficiency.
  • Shifts in the PPC.
  • Capital goods vs consumption goods.
  • Comparative advantage

34
Questions for you
  • What is the difference between unemployment or
    underutilisation of resources and a reduction in
    number of resources?
  • Why does the curve slope downwards?
  • What does the slope of the curve indicate?

35
Self-Discovery Slides
  • Types of Economic Systems
  • What is Free Enterprise (market system)?
  • How does it work?

36
Types of Economic Systems
Market forces
Government
Centrally Planned
Free Enterprise
Mixed
37
ECONOMIC SYSTEMS free-market economy
  • Free enterprise / free-market economy
  • - an economy where all economic decisions are
    taken by individual households and firms and with
    no government intervention

38
ECONOMIC SYSTEMS free-market economy
  • Main features of the free enterprise
  • Private ownership of all resources
  • Limited ownership by government
  • Freedom of choice
  • consumer sovereignty
  • consumers willingness and ability to pay ? high
    prices ? resources allocated into the production
    of this good

39
ECONOMIC SYSTEMS free-market economy
  • Freedom of choice
  • free enterprise for producers
  • governed by profit motive
  • ? producers can sell what they want to
  • free mobility of resources
  • governed by returns
  • ? factor owners are free to sell their factors
    anywhere

40
Economic Freedom
  • absence of obstacles to effective choices

Freedom of Enterprise
  • acquire any resource
  • use any technology
  • produce any product
  • charge at any price
  • invest their profits

Freedom of Consumer Choice
Freedom of Choice of Jobs
  • accept any job
  • quit any job
  • buy any product

41
ECONOMIC SYSTEMS free-market economy
  • Motivated by self interest
  • consumers - maximum satisfaction
  • producers - maximum profits
  • factor owners - maximum returns (rent, wages,
    interest)

42
Self-interest
Households
Firms
Aim to maximise profits
Consumers
Factor Owners
Aim to maximise their satisfaction / utility
Aim to maximise their factor income
43
ECONOMIC SYSTEMS free-market economy
  • Existence of competition
  • large numbers of buyers and sellers
  • free flow of information
  • little or no advertising
  • free entry and exit of firms

44
ECONOMIC SYSTEMS free-market economy
  • Meaning of price mechanism
  • the system in a market economy whereby changes in
    price in response to changes in demand and supply
    have the effect of making demand equal to supply

45
ECONOMIC SYSTEMS free-market economy
  • Price mechanism
  • determines the allocation of resources within the
    economy
  • works through interaction of demand supply and
    price signals
  • prices measure the value of goods and services
    measured in terms of standard monetary unit

46
PRICE MECHANISM
Consumers
Demand
Decisions
Prices
Producers
Supply
47
PRICE MECHANISM
Prices on Goods Mkts
Supply g s
Demand g s
Consumers expdt
Firms rev.
Firms
Households
WHAT? HOW? FOR WHOM?
Firms expdt
Factor income
Supply fop
Demand fop
Prices on Factor Mkts (wages, rents, interest)
48
What to produce?
  • Consumer sovereignty
  • Consumers, through their money votes, dictate
    what goods should be produced.

Demand for cars ?
Price of cars ?
Profits of car manufacturers ?
Firms will want to supply more cars
Workers other fops move away from other
industries into the auto industry
Firms pay more to attract workers other fops
49
How to produce?
  • Firms will choose the method of production which
    minimises the cost of production.
  • Hence, if the price of one resource is high
    relative to its productivity, producers will try
    to substitute a cheaper input for a more
    expensive one.

50
For whom to produce?
  • Since the demand for a good must be effective,
    i.e. backed by the ability to pay, goods will be
    produced for those who have the purchasing power
    (higher income).

51
ECONOMIC SYSTEMS free-market economy
  • Advantages of a free-market economy
  • functions automatically - no need for costly and
    complex bureaucracies to co-ordinate economic
    decisions
  • highly competitive market - more responsive to
    consumer wishes
  • efficient use of resources (what, how, how much
    and for whom to produce)

52
ECONOMIC SYSTEMS free-market economy
  • Problems of a free-market economy
  • competition between firms is often limited - a
    few large firms
  • lack of competition and high profits
    - little incentive for firms to be efficient
  • unequal distribution of power and property
  • ignore external costs of production
  • no production of public goods

53
ECONOMIC SYSTEMS free-market economy
  • Problems of a free-market economy
  • macroeconomic instability - periods of recession
    with high unemployment and falling output, and
    other periods of rising prices
  • by rewarding self-interest - may encourage
    selfishness, greed, materialism and acquisition
    of power

54
Features of the 3 Economic Systems
Free Enterprise System
Mixed Economy
Centrally Planned Economy
  • Command economy
  • Planned economy

Alternative Names
  • Laissez-faire
  • Capitalist system

55
Features of the 3 Economic Systems
Free Enterprise System
Mixed Economy
Centrally Planned Economy
  • US
  • UK
  • Singapore
  • North Korea
  • Cuba

Examples
  • Hong Kong

56
Features of the 3 Economic Systems
Free Enterprise System
Centrally Planned Economy
Mixed Economy
Features 1. Ownership of Resources / Factors of
Production (fops)
  • Private ownership (i.e. by individual households
    firms) of almost all fop
  • Public ownership (i.e. by the state) of almost
    all fop
  • Public private ownership

57
Features of the 3 Economic Systems
Free Enterprise System
Centrally Planned Economy
Mixed Economy
Feature 2. How economic decisions are made
  • Price mechanism
  • Govt directives
  • Price mechanism govt directives

58
Features of the 3 Economic Systems
Free Enterprise System
Centrally Planned Economy
Mixed Economy
Feature 3. Dominating motive
  • Self-interest common good
  • Self-interest
  • For the common good of the nation
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