People's Democratic Republic of Algeria
Minstery of higher Education and scientific research
National Polytechnic School Algiers
Common Core Department
Economics full course
For
First year Preparatory class
curriculum
Prepared by: Dr. S. Taleb
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Chapter 2: Production
Objectives of this chapter:
• Understanding the principle factors of production necessary for the
production in an economy
• Exploring the different allocative mechanisms for the use of the
factors of production
• Analyzing the production possibility curves (PPC), their tide relation
with the principle of opportunity cost, and economic growth.
I. Key definitions
market: a way in which buyers and sellers come together to exchange products
costs of production: the various costs involved in the production process, which can be
generally divided into fixed costs, which do not vary with changes in output, and variable
costs, which do vary with changes in output
fixed capital: buildings, plant, machinery and vehicles for commercial use that
are used in the production process
investment: spending on capital equipment, e.g. a machine or a piece of equipment that
can be used in the production process
working capital: the part of the capital of a business that is available to pay for wages and
materials and not tied up in fixed capital such as land, buildings or equipment
short run: the time period when it is not possible to change all of the factors of production
long run: the time period when it becomes possible to change all of the factors of
production
very long run: the time period when technical progress is no longer assumed to be
constant, as is the case in the short run and the long run, and the conditions of supply in an
industry can be affected, for example, by the impact of a new invention
positive statement: a statement which is factual and objective, based on empirical evidence.
For example: Increasing the taxes of the production of TV’s will lead to less sells.
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normative statement: a statement which is subjective and expresses a value judgement. For
example: The government should do everything it can to reduce the traffic in the capital.
Gross Domestic Product (GDP): It counts all of the output generated within a country in a
given period (one year) [1]
II. Factors of production:
1. land: the factor of production that includes all the gifts of nature, or natural resources, that
can be used in the process of production, e.g. minerals, forests and the sea
2. labour: the factor of production that includes all the human effort that goes into the
process of production, both mental and physical
3. capital: the factor of production that includes all the human-made aids to production, e.g.
tools, equipment and machinery
4. enterprise: the factor of production that refers to the taking of a risk in organizing the
other three factors of production
IV. Classification of goods and services:
public good: a good or service that is provided by the public sector, and otherwise would not
be provided, it is non-rival1, non-excludable 2, non-rejectable3 and for which it is usually
difficult to charge a direct price.
Merit good: A merit good is a particular type of private good. Like other private goods,
merit goods are both rival and excludable, but what distinguishes a merit good is the fact
that it is likely to be underproduced and underconsumed if provided through the private
sector, especially when the consumers are misinformed.
Demerit good: a product which is rival and excludable, and which, if left to a free
market, would be likely to be overproduced and overconsumed
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non-rivalry: where the consumption of a product does not prevent its consumption by someone else 2
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non-excludability: where the consumption of a product by one person does not exclude others from
consuming the same product
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non-rejectability: where individuals cannot unconsume a public good, even if they want to.
V. Allocative mechanisms:
The allocative mechanism deals with how people [2], businesses and governments make
choices about how to use the factors of production because of the scarcity problem.
There exist three different systems:
a) market economies
b) planned economies
c) mixed economies
1. Market economies:
It is an economy where decisions about the allocation of resources are taken through the price
mechanism of demand and supply.
Advantages of market economies Disadvantages of market economies
- Decisions are made by individual consumers, - Some products will be underprovided and
who act in their own self-interest, i.e. seek to under consumed in a market economy; these
maximize their utility or satisfaction when they are known as merit goods, e.g. education and
consume a product. healthcare.
- - Decisions are made by individual producers, - Some products will be overprovided and
who act in their own self-interest, i.e. seek to overconsumed in a market economy; these are
maximize their profits. known as demerit goods, e.g. alcohol and
tobacco.
- - The use of the price mechanism to allocate
resources (referred to as ‘the invisible hand’ by - Some products will not be provided or
the Scottish economist Adam Smith) means consumed at all in a market economy because it
that there is no need for any government would be impossible to charge a market price
intervention in the allocation of resources. for them; these are known as public goods, e.g.
defense and lighthouses.
2. Planned economies:
Planned economies, also known as command economies, involve the allocation of scarce
resources through government intervention with no (or very little) scope for market forces to
operate.
Advantages of planned economies Disadvantages of planned economies
- - Government intervention in the allocation of - A system with such a large amount of
resources means it can take decisions in the government influence and control will tend to
national interest, e.g. it can prevent the be bureaucratic and, as a result, may be
production of socially undesirable products inefficient.
such as drugs and pornography.
- The lack of competition and the lack of the
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- - The government can intervene to bring about a profit motive mean that products are often of
more equitable distribution of income and poor quality with consumers having little
wealth. choice.
3. Mixed economies:
A mixed economy combines elements of both market economies and planned economies, in
other words, there is some degree of state ownership and state intervention, but in many areas
of the economy market forces will be allowed to operate.
It could be argued that all economies today are, to some extent, mixed economies. However,
there are large differences between, China, where the government still plays an important role
in the allocation of resources, and the United States, where the government has only a limited
role in the allocation of resources.
VI. Production possibility curve:
1) production possibility curve (or frontier) “PPC”:
It is a graphic representation showing the maximum
combination of goods or services which can be
produced from given resources.
Any movement along the curve from point A shows
that the production of more of one type of good leads
to the production of less of the other (thus illustrating
the concept of opportunity cost) [3]. All points A, B,
Figure 1 Production possibility curve (PPC) [2]
C, D can be produced within the economy.
Point F, shows an underproduction and therefore inefficient use of resources.
Point G, is unreachable at the present time given the resources that the economy currently has.
2) Shape of the PPC and Opportunity cost: It is usually curves and not a straight line not all factors of
production are equally efficient. If we take for example the point C , if we want to move from point C
to point D, which means increasing manufactured goods by 5 units, we will be losing 10 units of the
non-manufactured goods. Therefore, the opportunity cost of increasing the manufactured goods by 5
units is 10 units of non-manufactured goods.
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3) Economic growth on the PPC:
The economic growth is an increase in the national
output of an economy over a period of time, usually
measured through changes in gross domestic product
(GDP). An increase in the quality or quantity of the
factors of production will increase the economy’s
productive potential, and this will result in a shift of the
PPC to the right, from PPC1 to PPC2.
Figure 2 Shift in the PPC as a result of economic
growth [1]
4) Production in sectors of the economy:
a) primary sector: production that takes place in agriculture, fishing, forestry, mining, quarrying
and oil extraction.
b) secondary sector: production that takes place in manufacturing, construction and energy
c) tertiary sector: production that takes place through the provision of services
References of the chapter:
[1] [Link]
product-GDP
[2] Grant, S. (2018). Cambridge IGCSE® and O Level Economics Coursebook. Cambridge
University Press.
[3] Joad, T. (2019). Pearson Edexcel International a Level Economics Student Book Ebook.
Pearson Higher Ed.