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The nature of the economic problem
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The basic economic problem arises as humans have unlimited wants and
resources* available to fulfill such wants are limited or finite. This is known as the
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problem of scarcity.
Due to scarcity, people are forced to make choices. Thus, individuals or
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governments have to rank their choices and decide the allocation of resources for
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production of goods that have top priority, as it is impossible to satisfy all wants.
a
eg
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*Resources available in the world are of two types:
Non-
Renewable
renewable
Renewable resources are commodities such as solar energy, oxygen, fish stocks or
forestry that is inexhaustible or replaceable over time.
Non-renewable resources are those which are available in fixed quantities and are
limited in supply. Examples include metal ores, oil and coal.
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When a choice is made, it results in an opportunity cost. It is the next best
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alternative that is forgone. For instance, an individual may have to choose between
studying for economics test or watch Netflix. If he decides to study for the test,
Netflix and chill becomes an opportunity cost.
tu
The economic problem of scarcity is faced by the agents such as consumers,
workers, producers and the government. Hence, each of them have to make a
c
choice, which results in an opportunity cost.
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Consumers
• An individual might be faced with a situation where he can either
buy airpods or apple watch with his current savings
a
eg
Workers
• A worker might face an opportunity cost in terms of his career
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choice. For instance, I can choose to be a teacher or an accountant
with my current credentials
Producers
• A producer have to decide what to make. In a given agricultural
field, a farmer might have to decide to grow wheat or tomatoes.
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Factors of Production
Resources are commonly known as factors of production. It includes all the inputs
used in the production of a good or service. There are four factors of production:
land, labor, capital and enterprise
Land:
It is quite a broad category as a factor of production in that it refers to all natural
resources. These resources are gifts that are given by nature. It can range from land
used for agriculture or commercial real estate, as well as the natural resources
derived from land. These resources can be renewable, such as forests, or non-
renewable such as oil or natural gas
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The income earned from land or other such natural resources is called rent.
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Labor:
Labor includes any human input. This includes both the mental and physical effort,
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involved in producing goods and services. On the mental side of this factor of
production are laborers like artists producing art, or programmers creating
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software. On the more physical side of labor might be food service workers,
construction workers, or factory workers.
The income earned by labor resources is called wages.
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Capital:
eg
These are man-made goods used in the production of other goods. Their use in
commercial production is what separates them from more widely used consumer
goods. It include hammers, forklifts, computers, and delivery vans.
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The income earned by owners of capital resources is called interest.
Enterprise:
It is the willing and ability to bear uncertain risks and to make decisions in a
business. Entrepreneurs are the people who organize the other factors of
production and which crucially bear the risk of losing their money in case of
business failure.
The income an entrepreneur receives is referred to as profit.
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FOP and Mobility
Geographically Mobile Occupationally Mobile
A land is perfectly immobile in the The occupational mobility of land
traditional sense as it is not possible is high. It can be used for a
Land
to move a piece of land from its number of purposes.
location
For instance, a school premise
However, in its wider sense, it can can be used as a hospital too
be moved to a certain extent
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Labor’s geographically mobility In case of an unskilled worker,
depends on factors such as: the occupational mobility of labor
remains high
Labor
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1. Visa Restrictions
2. Family Ties For skilled workers, it is difficult
3. Lack of information to switch occupations as
c appropriate skills and
qualifications may be required.
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The geo mobility of heavy The occupational mobility
machineries remains low or depends on the type of capital
immobile. In case of a coal mine good.
and a dock, it is in fixed position
a
Capital A delivery van for books can be
The geo mobility of screw drivers used by a pharmaceutical
eg
and other smaller capital goods company to distribute medicines.
remain high However, a coal mine
occupational mobility cannot be
changed as it has been made for
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specific purpose
An entrepreneur is geographically An entrepreneur is occupationally
mobile as someone who has been mobile because if he has the
successful in starting up and ability to bear risks and organize
Enterprise running a business in one country is fop for one business, he should be
likely to be successful in another able to do this for another
country also. business as well.
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FOP (Quantity and Quality)
Quantity Quality
The amount of physical land does The quality of land can be
not change much with time. It can improved by the use of fertilizers,
Land
however be impacted by natural less pollutants and proper
disasters drainage system.
Natural resources, especially non-
renewable resources are reduced by
use.
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The quantity of labor can be The quality of labor can be
increased by improved as a result of better
education, better training, more
Labor
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1. increase in the size of population experience and better healthcare.
2. increase in retirement age
3. reduction in the school leaving
age
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4. people switching from part-time
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work to full-time
The quantity of capital can be The quality of capital goods can
increased by buying more physical be improved by producing
a
capital goods from abroad. The technologically advanced capital
country can also invest money in goods. If the capital good is
eg
Capital producing more capital goods technologically advanced, it will
result in more productivity.
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The quantity of enterprise will The quality of enterprise can be
increase if there are more improved if entrepreneurs
entrepreneurs, reduction in both, received better education,
Enterprise corporate taxes and government training, healthcare and gain more
regulations. experience.
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Few Definitions in Economics
Goods
Economics
Free Goods
Goods
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Consumer
goods and Capital goods Public Goods Merit Goods
services
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Free Goods: A product that does not require any resources to make it and so does
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not have an opportunity cost
Economic Goods are those goods that require resources to produce it and therefore
has an opportunity cost. It can be further classified into consumer goods &
services, capital goods, public goods and merit goods.
a
Consumer goods satisfy human
eg
wants. They can be durable i.e.
long lasting such as cars,
televisions, furniture and
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computer. Non-durable consumer
goods perish or gets used up
quickly, for instance food, drinks,
petrol & washing powder
Consumer Services include when
someone performs services for
people to satisfy their wants or
needs. For e.g. banker, doctor,
insurance, cleaner, teacher or
policemen
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Capital goods are man-made
resources which help to produce
other goods and services. The
buying of capital goods is known
as an investment. For e.g. screw
drivers, drills, ploughs and lorries
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Public goods are provided by the
government to the general public
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because people need them, but will
not pay for them.
A government provides these
c goods & services as no private
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firm would wish to produce them
because nobody would pay for
their use.
For e.g. defense, law & order,
a
street light and light houses.
eg
Merit goods are provided by the
government because she thinks
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that the public deserves the goods
such as education and health care.
These goods provide benefits not
only to the recipient, but produces
welfare for the society.
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Production Possibility Curve
Definition of PPC
Production Possibility Curve
also known as production
possibility frontier shows the
maximum combination of
two goods, given that
resources in the economy are
fully and efficiently
employed and assuming a
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constant state of technology
tu
Points under, on and beyond a PPC
c
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a
eg
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The PPC helps us to examine various economic models. In the above figure:
Point A, B & C represents full employment of the resources. Each point lying on
the PPC is efficient and indicates no wastage of resources
Point F is beyond the curve and represents that with the current resources
available, the output combination at F is unattainable. This indicates the concept of
scarcity.
Point D & E represents unemployment of resources or underutilization of resources
as the production level is below full capacity, which represents inefficiency.
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Movement along a PPC
The concept of opportunity cost & choice can also be shown via the Production
Possibility Curve. Since the PPC is downward sloping, it shows that in order to
produce more of one good, resources have to be diverted away from the production
of the other good.
The concept of choice can be illustrated by the diagram as the economy has to
decide either to produce at Point A (200 Wheat & 300 Cotton) or Point B (160
Wheat & 400 cotton).
re
c tu
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a
eg
If the economy decides to move from Point A to B, it is giving up 40 output of
wheat to produce 100 additional output of cotton. In this example, opportunity cost
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or the next best alternative foregone, then is the 40 output of wheat
The economy has moved to Point B, it has made a choice and can no longer
produce at Point A
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Shifts in the PPC
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tu
An outward shift of the PPC An inward shift of the PPC represents
represents economic growth. For an a fall in the economy’s production
outward shift to occur, there has to be potential. For an inward shift to occur,
an increase in the quantity or quality
of resources. For instance:
c there has to be a decrease in the
quantity or quality of resources. For
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instance:
1. Advances in technology
1. Natural disasters
2. Improved education
2. Fall in the labor force
3. Increase in the labor force
a
3. Exhaustion of non-renewable
4. Discovery of new resources
resources
eg
5. Training of labor
4. Lack of investment in capital and
labor
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Few More Definitions in Economics
Micro Economics: The study of the behavior and decisions of household and
firms, and the performance of individual market
Macro Economics: The study of the whole economy, for e.g. unemployment,
inflation, economic growth and balance of payments.
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