Production Possibility Diagrams

A PPF shows the maximum combination of two goods that an economy can produce given the resources available.

PPFs are downwards sloping because gain in one good means sacrifice of another.

If the line is straight, the assumption has been made that the F.O.P.S are homogenous and the law of diminishing returns does not apply. A bowed curve is more realistic.

The law of diminishing returns: where increasing amounts of a variable factor are added to a fixed factor and the amount added to total product by each additional unit of the variable factor eventually decreases.

Features of the fundamental economic problem include under-use, full use, trade-offs, conflicting objectives and opportunity cost.

Opportunity cost – the benefit that would have been derived from the next best alternative forgone.

Scarcity, Choice and the Allocation of Resources

Scarcity is the excess of human wants and needs over and above the resources available to satisfy them.

Needs are finite, whereas wants are infinite.

The issue of scarcity raises three questions:

What should we produce? How should we produce it? Who should we produce it for?

The answers are provided by economic incentives, as these influence choices, and as economists we assume economic agents make rational decisions.

The environment is an example of a scarce resource, which is affected by economic decisions.

The Economic Objectives of Individuals, Firms and Governments

Individuals, firms and governments may have a range of economic objectives but in general:

                                                    Individuals aim to maximise satisfaction/utility.

                                                    Firms aim to maximise profit.

                                                    Governments aim to maximise social welfare.

Economic Resources

Economists classify economic resources into four factors of production:

Land – any naturally occurring substance extracted from the air, sea or earth.

Labour – employees.

Capital – any manufactured item used to produce another good or service.

Enterprise – has an idea, makes an investment, organises/manages the other factors of production.

Free good – any good that is not scarce.

Economic good – any good that is scarce and therefore can command a price when sold.

The Nature and Purpose of Economic Activity

Central purpose of economic activity: the production of goods and services to satisfy needs and wants, and thereby to improve economic welfare.

Production and consumption may include activities such as housework, DIY and benefits derived from the natural environment.