(1) Foundation: Choices and Trades-off

Production Possibility Frontier (PPF)

A curve showing the maximum attainable combinations of two goods that can be produced with available resources and current technology

Fundamental concepts illustrated by PPF

Scarcity, choice, opportunity cost and efficiency

Point on the PPF

Efficient production where all resources are fully utilised

Point inside the PPF

Inefficient production with underutilised resources

Point outside the PPF

Currently unattainable with existing resources and technology

Outward shift of PPF

Caused by economic growth or technological improvement

Bowed-out shape of PPF

Shows increasing marginal opportunity costs

Increasing marginal opportunity costs

As more of one good is produced, larger amounts of the other must be given up

Economic growth (in PPF terms)

An outward shift of the PPF as resources or technology improve

Technological change in one industry

Shifts only one axis of the PPF outward (e.g. improvement in wheat production only)

Review Q – What happens when a country uses all resources available?

It operates on its PPF (producing efficiently)

Review Q – Which fundamental concept does PPF illustrate?

Scarcity and opportunity cost

Opportunity cost

The highest-valued alternative that must be forgone to engage in an activity

Scarcity

The incompatibility between limited resources and unlimited wants

Review Q – What does scarcity stem from?

From limited resources versus unlimited wants

Trade-off (example)

Choosing to produce more sedans means fewer convertibles (Tesla example)

Review Q – If the economy moves down the PPF

It faces increasing marginal opportunity costs

Absolute advantage

Ability to produce more of a good or service than others using the same resources

Comparative advantage

Ability to produce a good or service at a lower opportunity cost than others

Basis for trade

Comparative advantage — not absolute advantage

Specialisation

Focusing production on goods where one has comparative advantage

Gains from trade

Both parties can consume beyond their own PPF by specialising and trading

Mutually beneficial trade

Occurs when each country specialises and trades for what it lacks

Review Q – Who has comparative advantage in an example of two countries?

The one with the lower opportunity cost in producing that good

Review Q – What is the basis for trade?

Comparative advantage

Market

A group of buyers and sellers and the arrangements through which they trade

Product market

Market for goods and services

Factor market

Market for factors of production — labour, capital, natural resources, entrepreneurship

Free market

Market with few government restrictions on production or trade

Review Q – According to Adam Smith, why do markets work?

Because individuals acting in self-interest are guided by the invisible hand to meet consumer needs

Invisible hand

Self-interest and competition lead to efficient market outcomes without central control

Price mechanism

Price changes signal producers to adjust output to match consumer demand

Property rights

Legal rights to the exclusive use of property, including buying and selling

Importance of property rights

Encourage production and exchange by providing security of ownership

Independent court system

Enforces contracts and property rights, creating trust in markets

Effect of weak property rights

Production falls and the economy operates inside the PPF

Review Q – Why are property rights essential to markets?

They protect ownership and encourage investment and trade