Microeconomics (VCE AOS1 - 2024) Part 1
Economics - Unit 3
Area of Study 1 - An introduction to microeconomics: the market system, resource
allocation and government intervention
The concept of relative scarcity, including needs, wants, resources, opportunity cost and
the production possibility frontier (PPF) model, and the three basic economic questions
Introduction to economics – Microeconomics vs Macroeconomics
Definition - Any place or region where production of goods and services takes place and income is made
from selling those goods and services.
A place where production, income and expenditure occur with the aim of allocating scarce productive
resources between competing uses in order to maximise living standards for its citizens.
Economic activity – Refers to the activities of individuals, households and governments in the production of
goods and services.
Economic activity is determined by the level of production, expenditure and income in the economy. The level
of economic activity impacts on society’s material living standards, the rate of unemployment, income and
inflation in the economy.
Microeconomics Macroeconomics
Microeconomics is the study of economic
behaviour of individuals as consumers.
It studies the role of individual markets, firms and
industries in allocating resources and how the
government intervenes in individual markets to
improve efficiency.
Studies the economy as a whole and looks at
aggregate levels of production, employment and
expenditure in the economy.
A study of how the economy as a whole is
performing (Combining all industries and the
overall state of the country’s economy)
Key Questions
Giving examples explain the difference between Microeconomics and Macroeconomics (3 marks)
Microeconomics looks at the smaller parts of the economy, whereas Macroeconomics looks at the economy
as a whole. For example, Microeconomics would look at the amount of growth in the beef industry in the
past year. Whereas, Macroeconomics would look at economic growth in Australia as a whole.
Microeconomics studies the various sectors of the economy and how they operate (such as the
manufacturing sector, mining etc.) and the decisions of individual consumers whereas macroeconomics
looks at the economy as a whole and how it is functioning (e.g. level of inflation, unemployment, income
distribution, etc.)
Microeconomics studies the small unit making up the whole economy such as individual industries, markets
and businesses while macroeconomics studies the economy as a whole such as aggregate demand,
national spending, employment and overall material living standards and production. e.g. a microeconomic
issue would be unemployment in the retail industry while a macroeconomic issue would be inflation rates, if
inflation rates were growing too fast
Relative Scarcity and opportunity cost
Relative Scarcity - The basic economic problem that our wants are unlimited (Infinite) while our resources
(Land, labour, capital and entrepreneurship) are limited (Finite). There is an imbalance between our wants
and our resources. Relative scarcity is the reason nations cannot produce everything they want to.
Examples of economic agents facing relative scarcity
Individuals
Deciding whether they are going to dedicate their labour resources to become a
teacher or firefighter (Any two professions work)
Deciding whether to dedicate their money towards shares or a house
Businesses
Allocating land towards producing strawberries or grapes
Allocating machinery to making alcohol or hand sanitiser
Government
Allocating government land to schools, recreation or mining
Allocating taxpayers funds towards education or healthcare
Definition of opportunity cost - The value of the next best alternative that is foregone when a choice is
made. The benefit foregone by a decision not to direct productive resources into their next best alternative
use.
When all resources are fully and most efficiently employed in production, a decision to produce more of one
type of g/s will result in a need to reduce production in some other areas.
Opportunity cost can be measured in dollar terms, time costs or external costs you transfer to others.
Study hint: Opportunity cost is only the value of the next best alternative, not the third, fourth and fifth
alternatives available to someone.
Examples of opportunity cost for economic agents
Individuals Governments Businesses
If you study for Accounting you may not be able to
go for a run, or study for Chemistry.
If you stay in school until Year 12 you may give up
the opportunity to earn an income from getting a
job.
If you spend $2,000 on an I-Phone the opportunity
cost is not the $1500 you spent it is the opportunity
to use that money to go on a holiday (If that is the
next best alternative)
If the government spends $30
billion on defence they may
have to cut back on welfare,
childcare, or health.
Whichever one they value
second most is the opportunity
cost (They are not all the
opportunity cost).
Allocating land to
strawberries may
come at the
opportunity cost
of not being able
to dedicate those
same resources
to raspberries
Study Hint: The opportunity cost of building a skate park is not the cost of the skate park it is the next best
alternative use of the funds required to build the park. The opportunity cost of sleeping in may be that you
missed your Economics class.
Study Hint 2: Weighing up the opportunity cost rather than the actual dollar cost of decision gives
economic agents a much clearer indication of where they should allocate their scarce resources. It lets them
know what they will be giving up if they choose to make a particular decision.
Key Questions
Explain how individuals deal with the problem of relative scarcity. Provide meaningful examples to
illustrate your answer (3 marks)
Individuals deal with the concept of relative scarcity by making choices. For example when deciding what to
eat for lunch with limited funds individuals must choose between having a sandwich or a bowl of chips.
Individuals also face scarcity with their time and must make choices about whether to go to university or
enter the workforce, whether to watch TV or sleep when arriving home from work or choosing which
profession they will enter upon leaving school
Define the term opportunity cost and explain how it is intrinsically linked to the concept of relative
scarcity (3 marks)
Opportunity cost is the value of the next best alternative that is sacrificed when producers, consumers or
governments decide to allocate their scarce resources in a particular fashion.
Relative scarcity means that our resources (Land, labour and capital) are limited relative to the demands
placed upon those resources. This forces economic agents to make decisions about how best to use
resources.
Once decisions are made about how resources will be used, it involves the sacrifice of an opportunity to use
those resources in an alternative way. The next best alternative that is sacrificed (or foregone) is the
opportunity cost.
Consider the decision to purchase a new car. Explain how an economist would include the concept
of opportunity cost into their decision making process.
The concept of opportunity cost would have a large impact on what type of car the consumer purchased.
When deciding to purchase a Ferrari for example consumers would weigh up the other cars they could have
purchased with that money, perhaps a Porsche or 11 Ford’s.
The opportunity cost may be the car they have to give up or the opportunity cost could be the next best
alternative of that money. This may be to save the money to buy a house, purchase jewellery or go on a
holiday. If the opportunity cost is too high the consumer is unlikely to make the purchase.
Explain the relationship between relative scarcity, economic decision-making and opportunity cost
(3 marks)
Relative scarcity is the basic economic problem facing all societies. It can be defined as the imbalance
between limited resources (that is, land, labour, capital and entrepreneurship) on one hand, and people’s
unlimited needs and wants on the other.
The existence of relative scarcity forces societies to make choices or decisions about how to allocate these
scarce resources to satisfy society’s needs and wants—that is, what sorts of goods and services should be
produced given the limited amount of resources available, and in what sorts of quantities should these
goods and services be produced.
This gives rise to opportunity cost, which is the value of the next best alternative foregone whenever
decisions are made about how to allocate the economy’s scarce resources between competing uses. For
example, if additional resources are allocated to education it might mean that fewer resources are available
for national defence.
Needs, wants and resources
Needs – A good or service necessary for someone’s survival
Note: Needs can be different based on the development of a society. Some would argue a mobile phone is
a need in Australia to function in current day society. This is unlikely to be considered a need in Ethiopia!
Wants – A good or service that is not necessary for one’s survival, but consumption of which adds to
someone’s quality of life.
It is sometimes difficult to identify if some goods and services are wants or needs. For example are
telecommunications, electricity and healthcare needs or wants?
Productive Resources (Factors of Production) - Productive inputs that are required by businesses to
make goods and services.
Study Hint: Factors of production are physical items and intangible services that are used in the production
process. If they are not used in production they are not a factor of production. People are not factors of
production if they are not working in some way to create economic activity
Land/ Natural Capital
Natural resources are the factors of production
found in nature, such as minerals, rainfall and the
environment.
Land includes all natural physical resources
E.g. Fertile farm land, the benefits from a
temperate climate or the harnessing of wind power
and solar power and other forms of renewable
energy.
Capital resources are manufactured items set
aside from past production, often involving physical
plant and
equipment (such as machinery, factories, power
generators, computer systems, trucks, dams,
railways and roads) used by businesses and
governments to help make other goods and
services.
Capital goods combine natural resources and
human intelligence and are used to produce other
consumer goods and services in the future.
Labour Entrepreneurialism
Labour is the human input into
production (Skilled and unskilled),
the physical effort by humans in
the production process.
An increase in the size and the
quality of the labour force is vital if
a country wants to achieve growth
and boost its productive capacity.
The skills of those individuals who combine our resources to
produce goods and services. An entrepreneur is an individual who
takes risks and supplies products to a market to make a profit.
Entrepreneurs will usually invest their own financial capital in a
business and take on the risks.
Their main reward is the profit made from running the business.
Study Hint: The main difference between labour and
entrepreneurship is that entrepreneurs take risks and receive either
a profit or loss for their efforts. Labour resources receive a wage or
salary.
Key Questions
Define ‘factors of production’ and explain why economists often refer to resources as ’factors of
production’. (2 marks)
Factors of production refer to the productive inputs used to make goods and services that are sold in the
market and consist of land, labour, capital and entrepreneurial resources.
Resources are referred to as factors of production because they are the key inputs in the production
process that allow a society to make goods and services to satisfy their wants and needs.
The higher the quality of a countries factors of production generally the more they can produce and the
higher their living standards.
What is the difference between entrepreneurial and labour resources (2 marks)
Entrepreneurs coordinate land, labour and capital resources to produce goods and services. They take risks
in hopes of generating a profit. Labour resources are mental and physical efforts of humans to the
production process of goods and services. Labour resources obtain a wage for their contribution to the
production process whereas entrepreneurs receive the profits of their business.
Why is a car waiting to be sold in a car year not an example of a capital resource
A car waiting to be sold in a car year is not an example of a capital resource since it is not directly involved
in the production of goods or services.
Define the meaning of capital resources. Explain why capital resources are an important influence
on a nation’s productive capacity and material living standards. (2 marks)
Capital resources combine natural resources and human intelligence and are used to produce other
consumer goods and services in the future.
They include hammer, machines and other man made products that humans use to complete tasks more
efficiently to try and maximise our productivity and produce as many goods and services as possible to
maximise our access to goods and services (Material living standards).
By investing in new technology and utilising our capital resources efficiently (Not letting them remain idle)
we can boost our productive capacity and produce a greater amount of goods and services at a cheaper
price
Explain what is meant by the following statement: ‘Economics is about how resources are allocated
among competing uses.’ (2 marks)
Our resources land labour and capital are finite or limited and can be used in a range of different ways.
For example water is a land resource that can be used for a range of competing uses including drinking,
watering plants, cleaning agriculture etc.
As a society we must make choices as to how we will utilise our scarce resources to maximise living
standards this is the goal of an economy.
The Production Possibility Frontier
Resource Allocation – Making decisions about how our scarce land, labour and capital inputs are to be
used in production
The Production Possibility Frontier – A diagram representing the production combinations available to an
economy or nation producing two goods or services.
Productive capacity – The maximum a country can produce when all it’s land, labour and capital
resources are fully employed
Study Hint: A countries productive capacity is limited by its quality and quantity of productive resources.
The size and education/ skills of the labor force, quality of capital, technology and infrastructure and the
quality and quantity of natural resources impact a nation’s ability to produce and living standards.
Assumptions of the PPF
- It assumes that only two types of output can be produced by a nation, in this case, the country can
produce goods or it can produce services (or perhaps some combination of the two).
- It is assumed that the nation fully uses its scarce natural, labour or capital resources to produce goods or
services, so that no resources are unemployed, wasted or lying idle (since this would mean that the
country was not operating at its capacity or potential output).
- At a point in time (e.g. 2023), the total quantity or volume of productive resources available for the nation
is fixed or limited, although how these resources are allocated between the production of goods or the
production of services (i.e. the product mix) can change.
- It is assumed that the nation uses the most efficient production methods now available, or the best
practice permitted by current technology
Shape of the PPF
Why is the PPF downward sloping Why is the PPF often bowed outwards
-
- The PPF slopes downwards because of relative
scarcity and opportunity cost.
- The more of one good or service that is produced
the less resources available to produce the other
good or service.
- In essence the greater the production of the good/
service on the Y-axis the less we can produce of
the good/ service on the X-axis.
-
- Resources are not equally suited to production of
both goods and services and therefore opportunity
cost varies along the PPF
- Initially an economy will choose the resources most
suited to producing that type of good or service and
therefore initially the opportunity cost is minimal.
The more resources we allocate to a good or
service the higher the opportunity cost (We are
shifting labour and capital resources less suited to
that type of production)
When would the PPF be linear
The PPF is linear when resources are equally suited to both types of production.
Therefore, opportunity cost remains constant along the PPF.
Each time you produce more of one good or service you give up the same amount of the other good or
service. This may be the case when producing grains and wheat.
Points inside and outside the PPF
Points inside the PPF Points outside the PPF
It means the combined production levels of both goods and
services too low to ensure all resources are fully employed.
There is unemployment of labour or other inputs to production.
We can produce more of either good or service without a trade-
off by simply working harder of using our resources more
efficiently.
If we are working within the PPF output levels are below the
economy’s potential capacity or maximum level of production.
Resources are not fully utilised and there is unemployment of
workers and idle capacity in factories.
Material living standards would fall as we are not maximising
production and poverty levels would rise.
Beyond the countries productive
capacity
Insufficient levels to enable such high
levels of output
Operating at this level would cause
inflation and increased prices
(Reducing purchasing power - MLS)
More importing as we are purchasing
more than we are producing –
Increasing our CAD (Current Account
deficit)
Shifting the PPF inwards and outwards
Shifting the curve out (Increasing our productive
capacity)
Shifting the curve in (Decreasing our productive
capacity)
Possible in the future by improving productivity or
access to resources (Quantity and quality of
resources) by:
Improving technology
Mineral Discoveries
Immigration
Better education and skill levels
Due to less access to resources
Droughts
Floods
Deaths of productive/ innovative people
Emigration
Questions
When would the PPF be diagonal or linear?
The PPF would be diagonal or linear when an economy's resources are equally suited to both type of
goods/services and the opportunity cost is constant along the PPF
Explain with reference to two goods (Not pizza's and robots) why the PPF is bowed outwards?
A hypothetical country that can only produce apples and iPhones will be bowed outwards because of the
different skill sets that the production of both goods requires.
As certain resources are more suited to the production of iPhone and vice versa the as more of apples that
are produced, the opportunity cost increases as we are now using up resources that would have been more
suited to the production of iPhones.
Explain using an example of two goods and services why opportunity cost is not constant along the
PPF?
Opportunity cost is not constant along the PPF because resources not equally suited to both types of
production. For example if we are producing robots and pizza’s.
If we are producing 200 robots and 0 pizza’s and decide to start producing pizza’s we are going to first use
all the chefs and capital resources that are most suited to producing pizza’s and least suited to producing
robots.
The opportunity cost of devoting resources to pizza’s initially is quite low (Resources are suited to this type
of production) however eventually as we move along the PPF our engineers will have to start making
pizza’s increasing the opportunity cost as they are not suited to this type of production.
Explain why the PPF is both downward sloping and bowed outwards in nature? Hint: You must use
an example of two different products in your answer
The PPF is downward sloping to signify the fact that when we produce more of a good or service it involves
a sacrifice in terms of how much of the other good or service that can be produced. The downward slope
recognises that there is an opportunity cost associated with every decision producers make.
The PPF is bowed outwards to signify that resources are not equally suited to either types of good or
service. For example if an economy was producing robots and pizza’s.
Some resources would be better suited to robots and other resources to pizza. This means the more of
either good or service we produce the higher the opportunity cost associated with devoting resources to that
type of production.
Explain the difference between a shift in the PPF inwards and an economy working within the PPF
When you are working within the PPF, you aren't using resources to their maximum potential, but you have
the same productive capacity. When there is a shift in the PPF inwards, the economy's productive capacity
has decreased due to the decreased access to resources (could be because of a drought or because
people have emigrated).
Hence, when there is a shift in the PPF inwards, the economy's ability, if all resources are fully employed, is
reduced whereas if an economy is working within the PPF, their ability hasn't changed, they are just not
using their resources as efficiently as possible.
Explain why points within the PPF do not necessarily involve a trade-off? (2 marks)
Points within the PPF represent that the economy is not working at its full productivity potential, (for the
specific goods or services) and that there are idle resources available.
This means that in order for more of a specific good or service to be made, we may not need to decide
between producing more of one product or another. It might just be a matter of working harder and using
our resources more efficiently.
Explain what is likely to happen to an economy's living standards if they produce within the PPF (2
marks)
The material living standards would fall as there wouldn't be enough goods to go around in the economy, as
we aren't working to our full potential.
Also, as there could be lots of unemployment and an underutilisation of workers, people would have less
income and there could be a rise in poverty levels which could impact NMLS through higher crime rates and
increased incidences of depression/social stigma
The three basic economic questions
What and how much to produce How to produce For whom to produce
Private market Private market Private market
Mainly based on consumer
sovereignty and the force of
demand and supply
Businesses are mainly privately
owned and self-interested owners
allocate their scarce resource to
products that will help generate
the most profit
This is largely based on
RELATIVE PRICES with self
interested producers shifting their
scarce resources to areas that
have the highest relative price
The decision of how to produce
refers to whether firms choose
to be labour or capital intensive.
This means will they use mainly
labour resources or capital/
machinery in the production
process.
Most businesses make this
decision based on what is most
profitable/ cost effective. If
labour is cheaper they will
choose to be more labour
intensive
The decision of for whom to
produce is mainly based on
individuals contribution to the
production process.
Those who own land or have
skills/ talents (Higher quality of
labour) that are in demand
generally generate higher
incomes (Wages, salaries, rent)
This allows them to purchase
more goods and services
Government Intervention Government Intervention Government Intervention
The government intervenes
Through the use of bans, taxes
and other restrictions to limit the
production of certain undesirable
products
E.g. Alcohol, weapons, drugs
They also promote the production
of socially desirable goods (Merit
goods) through the use of
subsidies and direct provision
through taxpayer funds
E.g. Education, healthcare,
prisons, emergency services
The government influences this
decision by impacting the
relative cost of using labour vs
capital through the use of
minimum wages, subsidies to
hire workers, tax concessions
or subsidies to invest in new
technology
The government influences for
whom to produce via providing
welfare, public housing and other
concessions to help ensure a
more equitable distribution of
income so more people can have
access to goods and services.
They also implement a
progressive tax system where the
rich pay a higher rate of tax.
Key Questions
Explain how the Australian economy answers the question of what to produce. In your answer refer
to the role of government intervention (3 marks)
In Australia we have a mix between a Market Capitalist economy and a Planned Socialist economy. This
means that 80% of resources are allocated by private businesses and 20% is redirected by the government.
What is produced is determined by consumer sovereignty where what is produced is determined by what
consumers demand.
As a result, self-interested producers will use their scarce resources to produce what consumers demand.
However, sometimes the government needs to intervene by placing taxes, limiting quantities or banning
certain goods and services which have negative externalities such as pollution, cigarettes etc.
Explain with reference to a current example how Australia answers the question of how to produce?
Australia answers the question of how to produce by using a combination of labour and capital resources
cheapest and most efficient for the business, which would maximise output and profits. Businesses can
either be labour intensive (relying mostly on workers/labourers) or capital intensive (relying most of
machinery).
For example, Coles is now using more self-service checkout machines in their stores instead of the
traditional method, as they have found it cheaper and more profitable.
Explain how the Australian economy answers the question of 'For whom to produce.' In your
answer explain how the government intervene in the market to make the distribution of income in
Australia more equitable (3 marks)
For whom to produce depends on people's contribution to the labour force, the value of their land and
labour and the amount of resources for production they own.
The higher the value of their labour and the more factors of production they own, the higher income they will
receive. As a result of this capitalist system of ownership, there is an inequity in income distribution.
The government intervenes through progressive taxes, welfare for those who have low incomes, public
services so that anyone regardless of income can access them, etc. This aims to make the distribution of
income more equitable.
The meaning and significance of economic efficiency, including allocative efficiency,
productive efficiency, dynamic efficiency and intertemporal efficiency and their relationship
to the PPF model
The meaning of each type of efficiency
An efficient allocation of resources - An ideal economic situation in which no other pattern of
output/production/ allocation of resources (Land/ labour and capital) other than that chosen by the nation
would provide greater satisfaction to the citizens. Welfare is maximised
An efficient allocation of resources requires:
- Productivity is maximised – We are getting the most out of existing resources
- We are producing the goods and services society values (Including third parties)
- Opportunity costs are minimised
- The satisfaction or utility of society is maximised
Labour Productivity - Output per labour hour of work. This is normally measured by GDP per hour worked
Capital Productivity - Output per machine hour
Multi-factor productivity - Output per (Labour hour and machine hour). Represents a measure of the
overall or combined efficiency or labour, capital and other resources.
Note 1: Productivity is not exactly the same as technical efficiency. A business that is technically efficient is
said to be maximising its productivity. If an economy is not achieving technical efficiency and achieves a
boost in productivity, the curve will not necessarily shift outwards. The economy will instead be no longer
working inside their PPC.
Note 2: The values society places on the goods and services produced is irrelevant when the focus is on
productive or technical efficiency as long as the production occurs on the PPC the nation is efficient in a
productive sense.
Technical Efficiency Allocative efficiency
Definition - Maximising output per unit
of input, achieving the least cost
method of production and minimising
the use of resources in production.
Obtaining the greatest possible
production of goods and services from
available resources (Land, capital and
labour used to their full potential).
Resources are not wasted in the
production process and an economy
is producing the best quality product
at the lowest opportunity cost.
Technical (technological) efficiency
will occur when it is not possible to
increase output without increasing
inputs (resources).
Productivity is at a maximum and
where average costs are at a
minimum.
Allocative efficiency is about ensuring the most efficient
allocation of scarce resources in an economy in a sense that
resources are producing the goods and services most valued by
society and living standards/ welfare is being maximized.
Allocative efficiency is about maximizing technical efficiency
whilst also producing what consumers desire (In both the short
and long term).
When allocative efficiency occurs no resources will be wasted
and it will be impossible to make someone better off without
making someone else worse off. Any change in the way our
resources are allocated will reduce national welfare or living
standards.
From a production point of view, the cost of producing a given
output is minimised (We are maximising our output from a given
quantity of inputs) and from a consumption point of view, the
goods and services produced by society will provide the highest
level of ‘collective’ satisfaction.
Note: It is important to maximise technical efficiency to help
ensure allocative efficiency as this will help ensure prices are
kept low and consumers can purchase more (Increasing their
purchasing power and material living standards).
Dynamic Efficiency Inter-temporal Efficiency
Dynamic efficiency refers to how quickly an economy can reallocate
resources to achieve allocative efficiency.
Relates to firms being creative and innovative, adapting to latest
technology and upgrading workers skills in response to changing
economic conditions.
Is it achieved when businesses can adapt their methods of production
and output quickly in response to changes in market conditions or
changes in technology (E.g. from point 1 to point 2)
If consumer sovereignty dictates something is in demand how quickly
we can produce that product. How quickly can we re-allocate resources
from one good/ service to another to achieve allocative efficiency?
Achieved when an ideal
balance is met between using
resources (Firms, gov’t or
nation) to satisfy needs and
wants today but conserving
resources for the future also.
A balance between resource
use for current use and that of
future generations.
How each type of efficiency is demonstrated on the PPF model
Technical Efficiency Allocative efficiency
All points along the PPF are technically efficient
They all represent combinations that involves a
nation fully utilizing their resources to maximize
output with no idle or unemployed resources
(Productivity is maximized)
It is represented by only one point on the PPF.
This point depends on consumers preferences and
what society values and will be different in each
nation
Assuming that neither good/ service is harmful for
society as a whole the allocatively efficient point
refers to the point on the PPF that maximize the
wellbeing/ living standards of society.
Dynamic Efficiency Inter-temporal Efficiency
Dynamic efficiency can be represented on the PPF
by how quickly a country can move from one point
on the PPF to another point when there is a
change in consumer preferences.
For example if the country above was working at
Point D (Producing more apples than oranges) and
then started to value oranges more then dynamic
efficiency would be represented by how quickly
they move from producing at Point D to Point C, B
or A where they are now producing more oranges.
Represented by the PPF not producing at either
extreme of the PPF when choices are capital or
consumer goods.
If there is too much consumption relative to
investment or too much investment relative to
consumption
Can also be shown if one axis is going to harm the
environment coal vs solar energy
Also included providing a balance between current
and future consumption
E.g. A mixture of consumer and capital goods
(Infrastructure)
Allocative Efficiency Dynamic Efficiency
Inter-temporal Efficiency Productive/technical efficiency
Summary of the Types of Efficiency and how they are represented on the PPF
Allocative Dynamic
Definition
Represents the most efficient
allocation of scarce resources for
an economy in the sense that for
any combination of scarce
resources the production of goods
and services that occurs is most
valued by society.
It results in a combination of g/s
being produced that maximises
national welfare/ living standards.
The most efficient allocation of
resources occurs when it is
impossible to increase production
and living standards by changing
the way resources are allocated
Refers to how firms or industries are able to respond
to changing market conditions or changes in
technology
If response is quick then dynamic efficiency is said to
be high
It is represented by the speed at which the economy
can reallocate is resources from the production of one
good or service to another or from a sub-optimal
allocation to optimal achieving allocative efficiency
E.g. Adapting quickly to renewable energy if new
technology is developed that encourages consumers
to use more renewable. If we need to produce
facemasks during the pandemic how quickly we can
shift resources into face masks to keep people safe
How it is
demonstrated
on the PPF
PPF of Health Food and
Illicit Drugs mainly health
food
Dependant on what society
values
How quickly production can move from one point on
the PPF to another point when societies preferences
change.
E.g. More demand for renewable energy quickly
shifting from one point to another
Technical/ productive Inter-temporal
Definition
Occurs when an economy is producing at its
maximum possible output and fully utilising its
resources. To achieve technical efficiency
Firms must be producing at the lowest possible
long run (average) costs and will mean output
from the available resources has been maximised
Firms must be maximising productivity E.g.
Getting the most out of their resources
No wastage of resources
E.g. There is no unemployment or idle/
underutilised capital and land resources
Refers to a firm, government or indeed
a nation having the right balance
between resources being used for
current, as opposed to future use
E.g. The Future Fund, Superannuation
Guarantee Scheme are policies to
improve inter temporal efficiency
The unsustainable use of a nation’s
resources (E.g. Depleting fishing stock)
is a common example of how inter-
temporal efficiency is not achieved
(E.g. Over use of common access
resources)
How it is
demonstr
ated on
the PPF
It is represented by the economy
producing at any point along the
PPF.
All points along the PPD are
technically efficient, regardless of
what combination of goods and
services are produced
Represented by the PPF not producing at either
extreme of the PPF when choices are capital or
consumer goods.
If there is too much consumption relative to
investment or too much investment relative to
consumption
Can also be shown if one axis is going to harm the
environment coal vs solar energy
Also included providing a balance between current
and future consumption
E.g. A mixture of consumer and capital goods
(Infrastructure)
Questions
Explain what is meant by an efficient allocation of resources. In your answer, make reference to
‘opportunity cost(s)’ (2 marks)
An efficient allocation of resources occurs when the nation’s resources (such as land, labour and capital)
are used across the economy in combinations and applications such that national living standards or
welfare are being maximised.
This means that the opportunity costs associated with the use of our resources are minimised for an
economy.
Accordingly, it is not possible to achieve a ‘better’ allocation of resources by moving resources away from
one activity and towards another. Such a change of resource allocation would necessarily result in higher
opportunity costs, as the value of the next best (alternative) use of the resources would, by definition, be
greater.
Explain the difference between productivity and efficiency. In your answer give examples of how
an economy can be productive but not necessarily efficient. (3 marks)
Productivity refers to the level of output per unit of input (technical efficiency)
Efficiency is about allocating resources in a manner that maximises the wellbeing/ living standards of
society. Resources (land, labour, and capital) are allocated in a way that opportunity cost and waste are
minimised and that there is no better way to allocate resources in the economy
Operating at maximum productivity does not necessarily mean that the business or firm is reaching
maximum efficiency as the goods and services being produced may not be valued or maximise the
living standards of society
The key point of difference therefore is that productivity only measures the output per unit of input whilst
efficiency also takes into account the types of g/s being produced and whether they benefit living
standards
For example if an economy was productively producing guns they could be productive but if the use of
these guns caused harm this would not be efficient.
Define technical efficiency and explain how it is represented on the PPF (2 marks)
Achieving technical efficiency means maximising output per unit of input, achieving the least cost
method of production and minimising the use of resources in production. There are no unemployed or
underutilized resources. Technical efficiency is represented by all points that are on the edge of the PPF.
Assume that an economy is not achieving technical efficiency and it achieves a boost in
productivity, illustrate how this is likely to impact the PPC (2 marks)
Assuming the increase in productivity stems from existing workers choosing to increase their output and
taking less breaks it will move the country closer to it’s PPF. This is because the quality and quantity of
resources hasn’t changed the country is simply using it’s existing resources more efficiently.
If the increase in productivity is caused by an increase in the quality of resources perhaps due to
improvements in skill levels, skilled immigration or technological advancements the PPC would shift
outwards.
Explain why every point on the PPF is considered technically efficient, but only one point on the
PPF is considered allocatively efficient. (3 marks)
Every point on thee PPF is considered technically efficient because at all points along the PPF society is
maximising its level of output per unit of input. If a country is working on its PPF it assumes no idle or
underutilised resources (No spare capital or labour that is not working as productively as possible). If
society is not achieving technical efficiency then we would be working inside the PPF).
However, working on the PPF does not imply allocative efficiency. To achieve allocative efficiency we
need to produce the combinations of goods and services that maximises societies welfare.
This implies producing what society values the most, not producing goods that are detrimental to society
like heroin or producing goods that consumers do not desire. There is only one point on the PPF where
a country is producing the combination of goods and services that best satisfies the wants and needs of
consumers and maximises the wellbeing of society.
Assuming two countries had exactly the same quality and quantity of resources. Explain why the
most efficient allocation of resources as depicted by a point on their respective PPC’s is unlikely
to be the same (3 marks)
The most efficient (Allocatively efficient) point is dependent on how society values different goods and
services. One country (Country A) may value pizza’s more than robots and therefore their allocative
efficient point would be at a production combination of more pizza’s than country B.
Country B allocatively efficient point may be with more robots being produced if that is what is going to
maximise the wellbeing/ living standards of citizens in that country.
Explain with the use of an example why a more technically efficient allocation of resources
might not be consistent with allocative efficiency (3 marks)
An increase in technical efficiency means we are maximising our volume of output per unit of input. This
should help keeps production costs low and prices cheap however it may not maximise allocative
efficiency if we are not producing what is most in demand by society.
We may be producing efficiently but if we are producing goods with harmful effects like illicit drugs or
goods that society does not demand (E.g. Woollen jumpers with koala’s on them) then we are not
producing goods of value and maximising citizen’s utility
It could also be argued that increasing technical efficiency may lead to overuse of scarce resource
harming future generations and hence reducing allocating efficiency.
What do you think would be the allocatively efficient point if we were producing health foods or
illicit drugs on a PPF? Justify your answer (2 marks)
The allocatively efficiency point is the point on the PPF where we are producing all healthy foods and no
illicit drugs. Illicit drugs are illegal as they can cause negative implication on society’s living standards
due to violence, destruction of property and various health issues. It is therefore optimal from societies
point of view to product no illicit drugs and all health foods.
Compare and contrast the differences between allocative and technical efficiency. In your
answer define both terms and make reference to the PPF (4 marks)
Allocative efficiency refers to an allocation of resources that maximises society’s welfare utility
Technical efficiency is about producing goods and services as productively as possible maximising
output per unit of input with no wastage.
Technical efficiency is achieved at all points along the PPF and ensures that no resources are wasted in
the production process.
This helps to keep prices down and maximise incomes helping to achieve allocative efficiency.
Achieving technical efficiency, however, does not ensure allocative efficiency is achieved.
Countries may be producing goods and services that society does not value (E.g. VCR Players in 2020)
or products that are detrimental to society. Allocative efficiency is only achieved at one point along the
PPF.
Whilst achieving technical efficiency is necessary to achieve allocative efficiency it does not guarantee
allocative efficiency.
Explain the difference between dynamic and inter-temporal efficiency 2 marks
Dynamic efficiency refers to how quickly businesses or an economy can shift their resources in order to
respond to changing consumer demands. Inter-temporal efficiency is about striking a balance between
maximizing living standards today and into the future.
The key difference is that dynamic efficiency is related to the ability of the country to adapt to changing
conditions in order to meet consumer demands whilst inter-temporal efficiency focuses more on maximizing
efficiency in the long term
Explain with reference to the profit motive why free and competitive markets are generally more
effective in achieving dynamic than inter-temporal efficiency 3 marks
In free markets, firms are self-interested and aim to maximize their profits. They value being dynamically
efficient in order to ensure that they are constantly meeting the demands or consumers.
This allows them to stay ahead of their rivals and maximize profits. For example if there is a trend amongst
consumers to buy small cars, producers will quickly shift resources into producing small cars in order to
meet the demands of consumers.
Producers are generally less concerned with being inter-temporally efficient, as measures to improve inter-
temporal efficiency do not always coincide with increased profits for businesses.
Companies may be prone to undertaking activities involving pollution, emitting carbon dioxide and
deforestation in order to maximize profits even though these behaviours may harm our living standards in
the long term.
Explain the relationship between dynamic and allocative efficiency. In your answer define both
types of efficiency and provide an example (4 marks)
Dynamic efficiency is how quickly a society can move from a sub-optimal allocation to an optimal allocation
of resources in response to changed conditions or incentives.
Allocative efficiency is the most efficient allocation of goods and services that are most valued by society; it
maximises national welfare and living standards, whilst minimising opportunity cost.
Dynamic efficiency is important because it allows us to quickly shift resources to where they are demanded,
ensuring society’s living standards are increased (higher production of goods and services in demand)
increasing allocative efficiency.
For example, there are high profits available in the Australian meat industry, with strong demand from
China.
If Australia is dynamically efficient, we can quickly get workers and new technology into that industry and
allocate land, labour and capital into the meat industry.
This all helps us to produce more, maximising our living standard through profits and achieving allocative
efficiency.