THE

ECONOMIZING
PROBLEM
CHAPTER II
 SPECIFIC OBJECTIVES:
1. To define scarcity.
2. To apply the concept of opportunity and trade off in any economic
activity.
3. To learn the concept of production possibility frontier (PPF):
4. To know the 3 basic economic questions.
5. To discuss the different economics systems.
6. To analyze the circular flow.
 SCARCITY
Scarcity refers to the limited nature of society’s resources.
- Deficit
- Limited
- There are fewer resources that are needed to fill human wants and
needs. These resources can come from the land, labor resources and
capital resources.
- Any item that costs something is scarce.
- If it were not scarce, it would be free or a free good and could have
as much as you wanted without paying for it.
- Once you pay a price for it, that item becomes an economic good,
which is defined as any good or service that has a price and is thus being
rationed.
Economics- the study of how society manages its scarce
resources, including:
How people decide how much to work, save, and spend and what
to buy
How firms decide how much to produce and how much worker to
hire
How society decides how to divide its resources between national
defense, consumer goods, protecting the environment and other
needs?

Scarcity refers to the essential fact that people’s wants, or desires

are always going to be greater that the resources available to fulfill
those wants.
 OPPORTUNITY COST AND TRADE OFF
Opportunity Cost- the highest valued, next-best alternative that
we sacrifice to satisfy another wants.
- The thing that is given up when give a choice.
- The thing you gave up and did not buy.
COST ≠ MONEY (cost is not always acquitted to money)
Cost = time (cost is the opportunity itself, it’s the ability to do
something else and not the monetary value of what we are giving
up).
Trade Off- is sacrificing a certain option to choose another
opportunity.
 OPPORTUNITY COST TRADE OFF
Refers to what a person could have done Describes what is sacrificed to something else
with what was sacrifice
Refers the next valuable opportunity Refers to two opportunities or more with
choice
Is the cost of opting one course of action Is the course of action given up to perform the
and foregoing another opportunity preferred course of action

One goes for a better alternative The action is completely foregone in the
selection process of what one wants
Cost is calculated by subtracting the Cannot be calculated
value of the chosen option from the value
of the most worthwhile option
Losses incurred are not taken into Is not directly related to what one sacrificed
consideration
A choice of better alternative is made The cost of other things one possesses is
hence more beneficial affected
Refers to the gain which was lost but Does not compute the gain or loss but is based
could have been made because of wrong on factors such as choice or time
decision making
Opportunity cost and trade off are two concepts that
are used in many life situations. The two concepts
came about due to the concept of scarcity, as people
must decide among many alternatives in alternatives
to spending their time and money. Opportunity coast
is hence the act of choosing a project over the other,
while Trade-off refers to other actions which a person
would be doing apart from what is doing. It is
important to understand the difference and learn
when to apply them in real life.
 THE PRODUCTION POSSIBILITY FRONTIER
(PPF)
Production Possibility Frontier (PPF) is a macroeconomics concept that
shows various combinations of two products or services using almost the
same and finite raw materials for production. It is a graphical
representation of two products or services which are dependent on the
same finite inputs for the production process. Here both the combination
of the goods and services takes place in such a way that the resources are
used in the most efficient and optimal manner. Thus, PPF makes allocation
of resources in the best possible manner which benefits both the
organization and the country.
Assumptions of Production Possibility Frontier

The first assumption of PPF is that it assumes the technological infrastructure

or setup remains unchanged.

The second assumption is that it takes into consideration only two products or
services, using the same resources. The companies having three or more such
products cannot use the PPF curve.

The third assumption of PPF is that both the products under the study have an
opposite relationship with each other. According to this principle, the
production of one product can only be increased with a decrease in the
production of others. This is because of limited input resources.
Why Production Possibility Frontier is useful?

PPF is useful for both the corporate organization and the government. In
companies, it is useful for determining the best product mix, with less cost and
higher returns. On the other hand, the Government uses the PPF tool for deciding
which goods and services to produce and which goods and services to import.
The Transformation Curve tells the government which products it can produce
with its full efficiency. It also tells the government that it is better to import a few
goods, as producing the same in the economy will not be beneficial.

If a country is not producing goods and services according to the PPF, then it can
be safely concluded that the limited resources at command are not managed in
an efficient way and the country’s economic stability, growth potential, cost of
production and GDP will be impacted. Thus, this macroeconomic principle is
useful for both the Organization and any Government at large.
CONCLUSION: Production Possibility Frontier is one of the most useful
concepts of Macroeconomics. Irrespective of its limitations and assumptions,
it is very useful for determining products and services for exports and
imports of the country. It makes the country or the company to work with its
full productivity and optimal utilization of available critical and limited
resources. This tool becomes important and comes handy while analyzing
the Economic Growth of the country. It gives various permutation and
combination of units of products on the same curve and shows the likely
change and impact on economic growth with its shifting. Thus, it becomes a
dominant tool for enhancing productivity.
 THE 3 BASIC ECONOMIC QUESTIONS

what how for whom

HOW

FOR WHOM
WHAT

should be should should

produced? thing be things be
produced? produced?
What to produce?

Given limited resources of labor, raw materials and time, economic agents
must decide what to produce. Most primitive economies concentrate on
producing food and shelter – the basic necessities of life. However, with
increased productivity, the economy has more available resources which can
be used for non-necessary goods, such as leisure and education.
In a free market, production is determined by market forces. Firms and
entrepreneurs will produce goods in demand by consumers. In a mixed
economy, with government intervention, the government may decide to
produce more public goods – which are not profitable but do improve
economic welfare.
How to produce?

The entrepreneur will try and produce goods for the most
profitable and cost-effective method. This motivation is behind
the growth of technology and more efficient production
methods, such as the assembly line. A government may
regulate production methods to limit damage to the
environment.
For whom to produce?

In a free market, goods are provided for those with the ability to
pay. This may be through a simple barter exchange or in more
advanced economies through cash payments. In more altruistic
societies, we may seek to produce goods and services for those,
who may not be able to afford them. For example, many western
economies provide health care free at the point of use.
 ECONOMIC SYSTEMS

ECONOMIC SYSTEM- is a set of institutional arrangements and a coordinating

mechanism that assist society to respond to the economizing problem.
-differ according to:
➢ Ownership of the factors of production.
➢ The method used to coordinate and direct economic activity.
 The Market System The Command System
(CAPITALISM) (SOCIALISM or COMMUNISM)

Private ownership of property Government owns most property

resources resources
Use markets and prices to Economic decision making occurs
coordinate and direct economic through a “Central Economic Plan”
activity
Each participant acts in his/her self- Central planning board decides on
interest use of resources, composition and
distribution of output and
organization of production.
Each agent seeks to maximize its
objective function ( example:
utility-consumers, profit-firms)
MIXED ECONOMY SYSTEM
In mixed economy system both public sector (government) and private sector participate in
the economy to produce and distribute goods and services. It has elements of capitalist
economy and socialist economy. Most of the current developing countries come under this
system.
Father of Economics -Adam Smith “Wealth of Nations” 1776
-main point invisible hand of free market system guides the distribution of goods and
services
-government should stay out of economics and allow competition to regulate market
-advantage of efficiency
-easy to regulate
-offers wide variety
Smith’s “invisible hand” is now called “voluntary exchange”
-leads better quality, lower prices and more variety
 CIRCULAR FLOW ANALYSIS

Introduction to the Circular Flow of Economic Activity:

The all-pervasive economic problem is that of scarcity which is solved by

three institutions (or decision-making agents) of an economy. They are
households (or individuals), firms and government. They are actively
engaged in three economic activities of production, consumption and
exchange of goods and services. These decision-makers act and react in such
a manner that all economic activities move in a circular flow.
CIRCULAR FLOW MODEL
Households:

Households are consumers. They may be single-individuals or group of

consumers taking a joint decision regarding consumption. They may also
be families. Their aim is to satisfy the wants of their members with their
limited budgets.
Households are the owners of factors of production—land, labor, capital,
and entrepreneurial ability. They sell the services of these factors and
receive income in return in the form of rent, wages, and interest and profit
respectively.
Firms/Businesses:

The term firm/business is used interchangeably with the term producer in

economics. The decision to manufacture goods and services is taken by a
firm/business. For this purpose, it employs factors of production and
makes payments to their owners. Just as household’s consumer goods and
services to satisfy their wants, similarly firms produce goods and services
to make a profit.
Government:

The government plays a key role in all types of economic systems—capitalist,

socialist and mixed. In a capitalist economy, the government does not interfere. It
simply establishes and protects property rights. It sets standards for weights and
measures, and the monetary system.
In a socialist economy, the role of the government is very extensive. It owns and
regulates the entire production and consumption processes of the economy, and
fixes prices of goods and services. In a mixed economy, the government
strengthens the market system.
It removes its defects by regulating the activities of the private sector and by
providing incentives to it. The government also uses resources to produce goods
and services itself which are sold to households and firms. These decision-making
agents take economic decisions to produce goods and services and to exchange
them to consume them for satisfying the wants of the whole economy.
 4 Factors of Production

Labor Land

Capital Entrepreneurs
 4 Factors of Production

These are workers.

LABOR
The factor payment
for labor is referred
to as “wages.”
 4 Factors of Production

This includes land that is

rented or purchased, as
well as other components
LAND like natural resources and
raw materials. The factor
payment for land is
referred to as “rent.”
 4 Factors of Production

This is money used to buy

the tools that labor
implements to convert land
CAPITAL (i.e., natural resources)
into goods. The factor
payment for capital is
called “interest.”
 4 Factors of Production

These are the people who put

the other three resources
together to create a successful
ENTREPRENEURS business. The factor payment
for entrepreneurs is called
“profit.”
THANK YOU !
see you next week