Economics

The concave (to the origin) shape of the curve stems from an assumption that resources are not perfectly occupationally mobile. Points outside the P.P frontier (to the North East) are unattainable under the present technical know-how. Points inside it say, H, would be inefficient since resources are not being fully employed, resources are not being properly used, or outdated production techniques are utilized. If production is on the frontier the resources are being fully utilized. Points on the production possibility curve such as B,C and E show the maximum possible output of the two commodities. Output G will only become a production possibility if the country's ability to produce increases and the production possibility curve moves outwards. This can happen when there are changes such as increase in the labour force, increase in the stock of capital goods (factories power stations, transport networks, machinery) and/or an increase in technical knowledge. SOME USES OF THE P-P FRONTIER The production-possibility Frontier represented as a single curve can help introduce many of the most basic concepts of Economics. For example Figure 1:1 can well illustrate the basic definition of economics we gave earlier in the chapter. There we defined economics as the science ofchoosing what goods to produce. Should we live in a fortress economy bristlingwith guns but with austere living habits as at point B in figure 1:1?, or should we reduce the military to a pittance and enjoy an economy of butter and chocolates, as in point E?. It thus means if the economy is operating at a point on the C D ? G ? H E F 0 1 2 3 4Lesson One 8 production possibility curve, then we can say that resources are being fully employed and that more of one good (guns) cannot be produced unless there is a reduction of the other good (butter). For additional resources to be devoted to gun production, they have to be diverted away from butter production. This illustrates the basic concept in economics – that of an opportunity cost. The production possibility frontier provides a rigorous definition of scarcity; Points A, B and C are feasible points, given the current state of technical knowledge and the available resources. Points to the right of and above the frontier (such as G) are infeasible; they cannot be attained without technical change or an increase in resource availability. The P-P frontier shows the outer limit of the combination of producible goods. Scarcity is a reflection of the fact that the P-P frontier constrains our living standards. The production-possibility schedule can also help make clear the three basic problems of economic life; What, How, and For whom to produce. What goods are produced and consumed can be depicted by the point that ends upgetting chosen on the P.P frontier? How goods are to be produced involves an efficient choice of methods and properassignments of different amounts and kinds of limited resources to the various industries. For whom goods are to be produced cannot be discerned from the P.P diagramalone. Sometimes, though you can make a guess from it. If you find a society on its P.P frontier with many yachts and furs, but few potatoes and compact cars, you might suspect that it enjoys considerable inequality of income and wealth among its people. As a final use, we might apply the reasoning of the P-P frontier to student life. Let's say you have only 40 hours a week available to study Economics and Financial Accounting I. What might the P-P frontier look like for knowledge (or grades) in Economics and Financial Accounting I. OR if the two commodities were grades and enjoyment what might the P-P frontier look like? Where are you? Where are your lazier friends positioned on the frontier? 6. THE CENTRAL ECONOMIC PROBLEM There are many economic problems which we encounter everyday – poverty, inflation, unemployment etc. However if we use the term The Economic Problem we are referring to the overall problem of the scarcity of resources. Each society has to make the best use of scarce resources. The great American economist Paul A. Samuelson said that every economic society has to answer three fundamental questions; What commodities shall be produced, clothes, food, cars, submarines etc. and in whatquantities? How shall goods be produced? That is given that we have scarcity of resources ofland, labour etc, how should we combine them to produce goods and services which we want?Lesson One 9 For whom shall goods be produced? Who is to enjoy and get the benefit of thenation's goods and services? Or to put it in another way, how is national product to be divided among different individuals and families? ECONOMIC SYSTEMS: DIFFERENT ANSWERS TO THE SAME QUESTION While there are a million variations on answers to these questions; when we look around the world we find that there are only a limited number of ways in which societies have set about answering them. These ways or methods are called Economic systems. They are free enterprise, centrally planned and mixed economies. We will now examine these briefly.Lesson One 10 a) THE FREE ENTERPRISE: THE PRICE SYSTEM The free market system is where the decision about what is produced is the outcome of millions of separate individual decisions made by consumers, producers and owners of productive services. The decisions reflect private preferences and interests. For the free enterprise to operate there must be a price system/mechanism. The price system is the situation where the vital economic decisions in the economy are reached through the workings of the market price. Thus, everything – houses, labour, food, land etc come to have its market price, and it is through the workings of the market prices that the "What?", "How?", and "For whom?" decisions are taken. The free market thus gives rise to what is called Consumer Sovereignty –a situation in which consumers arethe ultimate dictators,subject to the level of technology, of the kind and quantity of commodities to be produced. Consumers are said to exercise this power by bidding up the prices of the goods they want most; and suppliers, following the lure of higher prices and profits, produce more of the goods. The features of a free market system are: Ownership of Means of Production Individuals are free to own the means of production i.e. land, capital and enjoyincomes from them in the form of rent, interest and profits. Freedom of Choice and Enterprise Entrepreneurs are free to invest in businesses of their choice, produce any product oftheir choice, workers are free to sell their labour in occupations and industries of their choice; Consumers are free to consume products of their choice. Self Interest as the Dominating Motive Firms aim at maximising their profits, workers aim at maximising their wages, landowners aim at maximising their return from their land, and consumers at maximising their satisfaction Competition Economic rivalry or competition envisages a situation where, in the market for each commodity, there are a large number of buyers and sellers. It is the forces of total demand and total supply which determine the market price, and each participant, whether buyer or seller, must take this price as given since it's beyond his or her influence or control.Lesson One 11 Reliance on the Price Mechanism Price mechanism is where the prices are determined on the market by supply and demand, and consumers base their expenditure plans and producers their production plans on market prices. Price mechanism rations the scarce goods and services in that, those who can afford the price will buy and those who cannot afford the price will not pay. Limited Role of Government In these systems, apart from playing its traditional role of providing defence, police service and such infrastructural facilities as roads for public transport, the Government plays a very limited role in directly economic profit making activities. Resource allocation in a free enterprise Although there are no central committees organising the allocation of resources, there is supposed to be no chaos but order. The major price and allocation decisions are made in the markets. The market being the process by which the buyers and sellers ofa good interact to determine its price and quantity. If more is wanted of any commodity say wheat – a flood of new orders will be placed for it. As the buyers scramble around to buy more wheat, the sellers will raise the price of wheat to ration out a limited supply. And the higher price will cause more wheat to be produced. The reverse will also be true. What is true of the market for commodities is also true for the markets for factors of production such as labour, land and capital inputs. People, by being willing to spend money, signal to producers what it is they wish to be produced. Thus what things will be produced will is determined by the shilling votes of consumers, not every five years at the polls, but every day in their decisions to purchase this item and not that. The “How?” questions is answered because one producer has to compete with others in the market; if that producer can not produce as cheaply as possible then customers will be lost to competitors. Prices are the signals for the appropriate technology. The “for whom?” question is answered by the fact that anyone who has the money and is willing to spend it can receive the goods produced. Who has the money is determined by supply and demand in the markets for factors of production (i.e. land, labour, and capital). These markets determine the wage rates, land rents, interests rates and profits that go to make up people‟s incomes. The distribution of income among the population is thus determined by amounts of factors (person-hours, Acres etc) owned and the prices of the factors (wages-rates, land-rents etc). Advantages of a Free Market System Incentive: People are encouraged to work hard because opportunities exist forindividuals to accumulate high levels of wealth. Choice: People can spend their money how they want; they can choose to setup their own firm or they can choose for whom they want to work.Lesson One 12 Competition: Through competition, less efficient producers are priced out of themarket; more efficient producers supply their own products at lower prices for the consumers and use factors of production more efficiently. The factors of production which are no longer needed can be used in production elsewhere. Competition also stimulates new ideas and processes, which again leads to efficient use of resources. A free market also responds well to changes in consumer wishes, that is, it is flexible. Because the decision happen in response to change in the market there is no need to use additional resources to make decisions, record them and check on whether or not they are being carried out. The size of the civil service is reduced. Disadvantages of a Free Economy The free market gives rise to certain inefficiencies called market failures i.e. where the market system fails to provide an optimal allocation of resources. These include: Unequal distribution of wealth: The wealthier members of the society tend to holdmost of the economic and political power, while the poorer members have much less influence. There is an unequal distribution of resources and sometimes production concentrates on luxuries i.e. the wants of the rich. This can lead to excessive numbers of luxury goods being produced in the economy. It may also result to social problems like crimes, corruption, etc. Public goods: These are goods which provide benefits which are not confined to one individual household i.e. possess the characteristic of non-rival consumption and non-exclusion. The price mechanism may therefore not work efficiently to provide these services e.g. defence, education and health services. Externalities: Since the profit motive is all important to producers, they may ignore social costs production, such as pollution. Alternatively, the market system may not reward producers whose activities have positive or beneficial effects on society. Hardship: Although in theory factors of production such as labour are “mobile” and can be switched from one market to another, in practice this is a major problem and can lead to hardship through unemployment. It also leads to these scarce factors of production being wasted by not using them to fullest advantage. Wasted or reduced competition: some firms may use expensive advertising campaigns to sell “new” products which are basically the same as may other products currently on sale. Other firms, who control most of the supply of some goods may choose to restrictLesson One 13 supply and therefore keep prices artificially high; or, with other