lIJ

Introduction
LEARNING OBJECTIVES

1.1 INTRODUCTION
. What is an Economy?
. Why Study Economics?
1.2 SCARCITY
1.3 ECONOMIC PROBLEM
1.4 MEANING OF ECONOMICS
1.5 MICROECONOMICS AND MACROECONOMICS
. Microeconomics
. Macroeconomics
. Difference between Microeconomics and Macroeconomics--
1.6 CENTRAL PROBLEMS OF AN ECONOMY
. What to Produce
. How to Produce
. For Whom to Produce
1.7 OPPORTUNITY COST
1.8 PRODUCTION POSSIBILITY FRONTIER (PPF)
. Characteristics of PPF
. Attainable and Unattainable Combinations
. PPF and Opportunity Cost
. Change in PPF
1.9 SOLVED PRACTICALS

1.1 INTRODUCTION
Every field of study has its own language and its own way of thinking. For example,
mathematics talks about algebra, science deals with experiments, accounts deal with
profit and loss and so on. Economicsis no different. An Economist's language consists
of terms like demand, supply, market, etc. In the coming chapters, you will come
across many new terms and some familiar words that economists use in specialized
ways.
The most important purpose of this book is to help you understand an economist's
way of thinking. Of course, as one cannot become a mathematician overnight, in the
1.1
1.2 Introductory Microeconomics

same way, learning to think like an economist will take some time. Yet with a
combination of theory, numericals and live examples, this book will give you ample
opportunity to develop and practice this skill.
Beforeweproceedto themeaningof economics,let us first understandthemeaningof
economyand reasonfor studyingeconomics.

What is an Economy?
You must have observed many activities happening around you in your daily life.
For instance, you may have seen factories, mines, shops, offices, flyovers, railways,
etc. All these institutions and organisations may be collectively called an economy.
Such units enable people to earn an income and, at the same time, help to produce
goods and services which people require for use.
An economy is a system which provides people, the means to work and earn a living.
It is an organisation that provides living to the people. In this task, it makes use of
the available resources to produce those goods and services that people want. For
example,Indian economy consists of all sources of production in agriculture, industry,
transport and communication, banking, etc. .

Vital Processes of an Economy

Economy is a system which provides living to the people. For this objective to be
fulfilled, it is necessary that every economy should undertake three economic activities:
1. Production
2. Consumption
3. Investment or Capital [Link].
These economic activities are known as the essentials or the vital processes of an
economy.
On the basisof natureof economicactivities,economiescanbe broadlyclassifiedas:
MarketEconomyand [Link],it is now out of syllabusand is
givenin PowerBoosterSectionfor knowledgeenrichment.

Why Study Economics?

We go to a cinema hall to watch a movie. We go to a restaurant to eat. We attend
school to get educated or to be able to earn a living. It means, every activity is
conducted for a specific reason. Economics is studied because it enables us to
understand different aspects of the economy.
However, the main reason for study of economics can be simplified to a single word
- Scarcity. We all know, human wants are more than the available resources. So,
there is a need to allocate these scarce resources for the satisfaction of never ending
human wants. Hence, Economicsis concernedwith selectionof resourcesunder conditions of
scarcity.
Let us now understand the concept of 'Scarcity', the root of all economic problems.
Introduction 1.3

1.2 SCARCITY
Scarcity refers to the limitation of supply in relation to demand for a commodity.
It refers to the situation, when wants exceed the available resources. As a result,
goods are not readily available and society does not have enough resources to satisfy
all the wants of its people. Scarcity is universal, i.e. every individual, organisation
and economy faces scarcity of resources.
Scarcity of resources calls for economizing of resources. Economizing of resources
refers to making optimum use of the available resources. There is a need to economize,
as we have to satisfy our unlimited wants out of limited resources.
Scarcity is not the only problem!
. Limitation of resources is not the only problem. In addition to being scarce,
resources also have alternate (different) uses. Alternate use of resourcesmeans
that a resource can be put to more than one use.
. For example, we all kn?W, petrol is scarce in relation to its demand. But there
is one more problem. In addition to its scarcity, it is used not only in vehicles,
but also in machines, railway engines, airplanes, generators, etc.
. Whenever, a commodity is chosen for one use, other valuable uses will have
to be rejected. It gives rise to the problem of choice.
For, "Scarcity and Choice go together", refer HOTS.

1.3 ECONOMIC PROBLEM

As we know, human wants are unlimited, but the means to satisfy them are limited.
Therefore, all our wants cannot be fulfilled. In order to maximise satisfaction, every
consumer exercises choice, as to which goods should be consumed and in what
quantity. An economicproblemis basicallya problemof choice.
Economic problem is a problem of choice involving satisfaction of unlimited wants
out of limited resources having alternative uses.
Reasons for Economic Problem
The 3 main reasons for existence of economic problems are:
(i) Scarcity. of Resources: Resources (i.e. land, labour, capital, etc.) are limited
in relation to their demand and economy cannot produce all what people
want. It is the basic reason for existence of economic problems in all economies.
Scarcity is universal and applies to all individuals, organisations and countries.
There would have been no problem, if resources were not scarce.
(ii) Unlimited Human Wants: Human wants are never ending, i.e. they can never
be fully satisfied. As soon as one want is satisfied, another new want emerges.
Wants of the people are unlimited and keep on multiplying and cannot be
satisfied due to limited resources.
Human wants also differ in priorities, i.e. all wants are not of equal intensity.
1.4 Introductory Microeconomics

For every individual, some wants are more important and urgent as compared
to others. Due to this reason, people allocate their resources in order of
preference to satisfy some of their wants. If all human wants had been of equal
importance, then it would have become impossible to malre choices.
(Hi) Alternate Uses: Resources are not only scarce, but they can also be put to
various uses. It makes choice among resources more important. For example,
petrol is used not only in vehicles, but also for running machines, generators,
etc. As a result, economy has to make choice between the alternative uses of
the given resources.
Resources Vs Human Wants
Features of Resources:
(i) They are scarce, i.e. their supply is limited in relation to demand. .

(ii) They have alternative uses.

Features of Human wants:
(i) They are unlimited, i.e. they can never be fully satisfied.
(ii) They differ in priorities.

1.4 MEANING OF ECONOMICS

Economics is a social science which studies the way a society chooses to use its
limited resources, which have alternate uses, to produce goods and services and to
distribute them among different groups of people.

WhyEconomics is considered a social science?

. The term 'Science' stands for al'1Ysystematic and organised body of knowledge.
Economics is also a science as it is a systematic and organised study of
economic behaviour of human beings.
. However, it is not an exact science like Physics and Chemistry as it deals
with the study of human behaviour. Therefore, it is known as social science.
What is Economics all about?
Economics is all about making choices in the presence of scarcity. It studies human behaviour
as a relationship. between means (resources) and ends (human wants). Economics
aims to ensure that the resources are used in the best possible manner.
Economics can be either 'Positive Science' or 'Normative Science'. But, it is now out of
syllabus and is given in Power Booster Section for knowledge enrichment.

1.5 MICROECONOMICS AND MACROECONOMICS

The subject matter of economics has been studied under two broad branches:
1. Microeconomics(Price Theory) 2. Macroeconomics (Income Theory)
These two concepts have become of general use in economics. Let us discuss these
concepts in detail.
Introduction 1.5

Microeconomics
Adam Smith is considered to be the founder of the field of microeconomics. The
term 'micro' has been derived from Greek word 'mikros' which means 'small'.
Microeconomics deals with analysis of behaviour and economic actions of small and
individual units of the economy, like a particular consumer, a firm or a small group
of individual units. The concept of microeconomics is very important as it supplies
the foundation for most of our understanding of the functioning of an economy.
Microeconomics is that part of economic theory, which studies the behaviour of
individual units of an economy. For example, Individual income, individual output,
price of a commodity, etc. Its main tools are Demand and Supply.
Macroeconomics
The term 'macro' has been derived from the Greek word 'makros' which means
'large'. So, macroeconomics deals with overall performance of the economy. It is
concerned with study of problems of the economy like inflation, unemployment,
poverty, etc. .

Macroeconomics is that part of economic theory which studies the behaviour of

aggregates of the economy as a whole. For example, National income, aggregate output,
aggregate consumption, etc. Its main tools are Aggregate Demand and Aggregate Supply.
Micro Vs Macro
. In Microeconomics, the letter 'I' stands for 'Individuals', i.e. it studies the
economic behaviour of individuals.
. In Macroeconomics, the letter' A' stands for' Aggregates', i.e. it studies the
economy as a whole.
Let us discuss the detailed differences between the two branches of economics.
Difference between Microeconomics and Macroeconomics
Basis Microeconomics Macroeconomics

Meaning Microeconomics is that part Macroeconomics is that part

of economic theory which of economic theory which
studies the behaviour of studies the behaviour of
individual units of an aggregates of the economy
economy. as a whole.
Tools Demand and Supply. Aggregate Demand and
Aggregate Supply.
Basic It aims to determine price of It aims to determine income
Objective a commodity or factors of and employment level of the
production. economy.
Degree of It involves limited degree of It involves the highest degree
Aggregation aggregation. For example, of aggregation. For example,
market demand is derived aggregate demand is derived
by aggregating individual for the entire economy.
demands of all buyers in
the particular market.
 1.6
Introductory Microeconomics

Basis Microeconomics Macroeconomics

Basic It assumes all the macro It assumes that all the micro
Assumptions variables to be constant, variables, like decisions of
Le., it assumes that national households and firms, prices
income, consumption, of individual products, etc.
savings, etc. are constant. are constant.
Other It is also known as 'Price
Name It is also known as 'Income
Theory'. and Employment Theory'.
Examples Individual income, individual National Income, National
output. output.

Interdependence of Microeconomics and Macroeconomics

Eco~omics is a single subject and the analysis of an economy cannot be split into two
watertight compartments. It means, microeconomics and macroeconomics are not independent
of eachother and there is much commonground betweenthe two. It means, both
microeconomics and macroeconomics are interdependent.
Let us elaborate their interdependence with the help of some examples:
Microeconomics depends on Macroeconomics
1. Law of demand came into existence from the analysis of the behaviour of a
group (aggregate) of people.
2. Price of a commodity is influenced by the general price level prevailing in the
economy.
Macroeconomics depends on Microeconomics
1. National income of a country is nothing but the sum total of incomes of
individual units of the country.
2. Aggregate demand depends on demand of individual households of the
.
economy.
Micro-Macro Paradoxes
Paradoxis a seeminglyabsurdor contradictorystatement,though,oftena true statement.
Sometimes, there are paradoxes seen in Micro and Macro activities. It means, an act
which is beneficial for an individual, may prove to be harmful for the economy as a
whole.
Example:If an individualsaves,his familywill be benefitted,but if the wholeeconomy
starts saving,it will resultin contractionof demand,output,employmentand income.
As a result,the wholeeconomywill suffer.
Which is more Important - Microeconomics or Macroeconomics?
Both, microeconomics and macroeconomics have a place of their own and none of
them can be dispensed with. Microeconomics concentrates on the working of the
individual components and macroeconomics studies the economy in general. While
the former is concerned with structures of the aggregates, the latter is concerned
Introduction 1.7

with the aggregates themselves. So, both the approachesare supplementary to eachother.
Thesuperiority of oneapproachover the other cannot beclaimed.
Need for a Separate Theory of Macroeconomics
Microeconomics failed to study the aggregates of the economy as a whole. As a
result, there was a need for a separate theory, which could explain the working of
the economy. Macroeconomicshelps to understand theworking of an economicsystemaswell
asto explain the various macroeconomicparadoxes.

1.6 CENTRAL PROBLEMS OF AN ECONOMY

Production, distribution and disposition of goods and services are the basic economic
activities of life. In the course of these activities, every society has to face scarcity of
resources. Because of this scarcity, every society has to decide how to allocate the
scarceresources. It leadstofollowing CentralProblems,thatarefacedby everyeconomy:
1. What to produce
2. How to produce
3. For whom to produce
These
problems arecalledcentralproblemsbecause
thesearethemostbasicproblemsofaneconomy
andall otherproblemsrevolvearoundthem.
These3 problemsare studiedundertheproblemof 'Allocationof Resources'.
Allocation of Resources (Studied under Microeconomics)
refersto theproblemofassigningthescarceresourcesin such a manner
Allocationof resources
sothat maximumwantsof thesocietyarefulfilled. As resources are limited in relation to
the unlimited wants, it is important to economize their use and utilize them in the
most efficient manner.
The problem of allocation of resources is studied under 3 heads: (1) What to produce;
(2) How to produce; (3) For whom to prod1,1ce.
In nutshell, an economy has to allocate its resources and choose from different potential
bundles of goods (What to produce), select from different techniques of production
(How to produce), and decide in the end, who will consume the goods (For whom to
produce).

1. What to Produce
This problem involves selection of goods and servicesto beproducedand the quantity
to be produced of each selected commodity. Every economy has limited resources
and thus, cannot produce all the goods. More of one good or service usually means
less of others.
Forexample,production of more sugar is possible only by reducing the production of
other goods. Production of more war goods is possible only by reducing the production
of civil goods. So, on the basis of the importance of various goods, an economy has to
1.8 Introductory Microeconomics

decide which goods should be produced and in what quantities. This is a problem of
allocation of resources among different goods.

The problem of 'What to produce' has two aspects:

(i) What possiblecommoditiesto produce:An economy has to decide, which consumer
goods (rice, wheat, clothes, etc.) and which of the capital goods (machinery,
equipments, etc.) are to be produced. In the same way, economy has to make a
choice between civil goods (bread, butter, etc.) and war goods (guns, tanks, etc.).
(ii) How much to produce:After deciding the goods to be produced, economy has to
decide the quantity of each commodity, that is selected. It means, it involvesa
decision regarding the quant~ty to be produced, of consumer and capital goods, civil and
war goodsand so on. \
'Guiding Principle of 'What to ~rod(Jce': Allocate the resources in a manner which
gives maximumaggregatesatisfaction. .

2. How to Produce
This problem refers to selection of technique to be used for production of goods and
services. A good can be produced. using different techniques of production. By
'technique', we mean which particular combination of inputs to be used. Generally,
techniques are classified as: Labour intensive techniques (LIT) and Capital intensive
techniques (CIT).
. In Labourintensive technique,more labour and less capital (in the form of machines,
etc.) is used.
. In Capital intensive technique, there is more capital and less labour utilization.
For example,textilescan be producedeitherwitha lot of labourand a little capitalor
withless labourand [Link] factorsand their relativepriceshelps
in determiningthe techniqueto be used.
The selection of technique is made with a view to achieve the objective of raising the
standard of living of people and to provide employment to everyone. For example, in
India, LIT is preferred due to abundance of labour, whereas, countries like U.S.A.,
England, etc. prefer CIT due to shortage of labour and abundance of capital.
Guiding Principle of 'How to Produce': Combine factors of production in such a manner
so that maximum output is produced at minimum cost, using least possible scarce
resources.

3. ForWhom to Produce
This problem refers to selection of the category of people who will ultimately consume
the goods, i.e. whether to produce goods for more poor and less rich or more rich and
less poor.
Since resources are scarce in every economy, no society can satisfy all the wants of its
people. Thus, a problem of choice arises. Goods are produced for those people who
Introduction 1.9

have the paying capacity. The capacity of people to pay for goods depends upon
their level of income. It means, this problem is concerned with distribution of income
among the factors of production (land, labour, capital and enterprise), who contribute
in the production process.
The problem can be categorised under two main heads:
\ (i) Personal Distribution: It means how national income of an economy is
I distributed among different groups of people.
rOO Functional Distribution: It involves deciding the share of different factors of
( production in the total national product of the country.
Guiding Principle of 'For whom to Produce': Ensure that urgent wants of each
productive factor are fulfilled to the maximum possible extent.
It must be noted that in addition to 'Allocation of Resources', there are two more Central
Problems: (i) Problem of .fuller and efficient utilsation of resources; (ii) Problem of
Growth of resources. However, they are beyond the scope of syllabus of XIPhclass.

1.7 OPPORTUNITY COST

As resources are scarce, the society is always forced to make choices. To produce
more of one good, a certain amount of other goods has to be sacrificed. The true cost
of using economic resources in any given project is the loss of the alternative output
which they might have produced.
For example, if we use a certain amount of land, labour and capital to build a factory,
then the economic cost (or opportunity cost) of the factory might be the houses which
these resources could have produced.

Hence, Opportunity Cost is the cost of next best alternative foregone. For example,
Suppose, you are working in a bank at the salary of Rs. 40,000 per month. Further
suppose, you receive two more job offers:
.. To work as an executive at Rs. 30,000 per month; or
To become a journalist at Rs. 35,000 per month.
In the given case, the opportunity cost of working in the bank is the cost of next best
alternativeforegone, i.e. Rs. 35,[Link] othergoodsandservices,that must be
sacrificedto obtainmoreof anyonegood,is calledtheopportunitycostof thatgood.

One more Example

Suppose you have Rs. 20,000 and you want to purchase one computer and a LCD TV.
With Rs. 20,000 only in hand, you cannot have both. You can either buy computer or
LCD TV. If you decide to purchase computer, then opportunity cost of choosing the
computer is the cost of the foregone satisfaction (from LCD TV).This exampleclearly
demonstratesafundamentaleconomiccondition:'As our resources arelimited,wearealways
forcedtomakechoicesbetweenalternatecommodities',
1.10 Introductory Microeconomics

1.8 PRODUCTION POSSIBILITY FRONTIER (PPF)

Due to scarcity of resources, we cannot satisfy all our wants. Even if an economy
uses all its resources in the best possible manner, its capabilities are restricted due
to scarcity of resources. As we cannot have everything that we want, we are forced
to make economic decisions. These decisions take the form of choices among
alternate goods and services, that will best satisfy our wants. Thus, the society must
decide, what to produce out of an almost infinite range of possibilities.
As the choice is to be made between infinite possibilities, the economists assumed a
very basic economy with only two goods (say, guns and butter). Economists have
traditionally represented this range of choices by what they call a 'Production Possibility
Schedule' (Table 1.1). When this schedule is graphically represented (Fig. 1.1), it is
. called 'Production Possibility Frontier (PPFY or 'Production Possibility Curve (PPC).
Production Possibility Frontier (PPF) refers to graphical representation of possible
combinations of two goods that can be produced with given resources and technology.
Alternately, PPF is the locus of various possible combinations of two goods that can be produced
with given resources and technology.
Only 2 Goods are taken: The two goods have been taken just for the sake of simplicity
and easy [Link],the analysis involved can be applied equally well, to
any combination of goods.

Synonyms of PPF .
PPF is also known by the following names:
. Production Possibility Curve. Production Possibility Boundary
.. Transformation
Curve
Transformation Frontier
. TransformationBoundary

Assumptions for PPF

Production possibility frontier is based on the following assumptions:
1. The amount of resources in an economy is fixed, but these resources can be
transferred from one use to another;
2. With the help of given resources, only two goods can be produced;
3. The resources are fully and efficiently utilised;
4. Resources are not equally efficient in production of all products. So, when
resources are transferred from production of one good to another, the
productivity decreases;
5. The level of technology is assumed to be constant.
The concept of PPF can be better understood with the help of following imaginary
(hypothetical) schedule and diagram:
Introduction 1.11

Table 1.1 - Production Possibility Schedule

Possibilities Guns (in units) Butter (in units) MOC MRT = Guns
8utter
A 21 0 - -
8 20 1 1 1G: 18
C 18 2 2 2G: 18
D 15 3 3 3G: 18
E 11 4 4 4G: 18
F 6 5 5 5G: 18
G 0 6 6 6G: 18

Table 1.1 shows the various possibilities of guns and butter. This data is graphically
represented in Fig. 1.1.
If the economy uses all its resources to y PPF of Guns and Butter
produce only guns, then maximum of 21 units
of guns and no [Link] can be produced (point
'A').
. On the other hand, if all resources are used ~c 15-1 .. .'..-
,
D
: ~.
for butter, then maximum 6 units of butter .~ 12+-- --.:. - .:--,\E
and no guns can be produced (point 'G'). i
~

, ,: : :,
. . .
. In between, there are various possibilities <3 96-1-..~- - .:.. .:. - - ~.. \F
with different combinations of guns and ., '. .. '' ,,
butter. 3 ,. .' .. ' ,
: : : ' , \G x
. When points A, B, C, D, E, F and G arejoined, we 0 2 3 4 5 6
get a curve AG, known as 'ProductionPossibility Butter (in units)

Frontier'.AG curve shows the maximum limit Fig. 1.1

of production of guns and butter.
Marginal Opportunity Cost (MOC)
MOC refers to the number of units of a commodity sacrificed to gain one additional unit of
another commodity. In case of PPF, MOC is always increasing, i.e. more and more
units of a commodity have to be sacrificed to gain an additional unit of another
commodity.

Why Increasing MOC operates?

Increasing MOC operates because productivity and efficiency of factors of
productiondecrease as they are shifted from one use to another. Let us understand
this with the help of an example: Suppose an economy produces only two goods
(say, guns and butter). A worker is employed in production of guns because he is
best suited for it. If economy decides to reduce production of guns and increase
productionof butter,then workerwill be transferredto productionof [Link],
he is not that efficient in production of butter as he was in guns. As a result, his
productivity in butter will be low and MOC will increase.
1.12 Introductory Microeconomics

Marginal Rate of Transformation (MRT)

MRT is the ratio of number of units of a commodity sacrificed to gain an additional unit of
. ~ Units Sacrificed .
anothercommodIty. MRT = . In the gIVenexample of guns and butter,
~ Units Gained
MRT = ~ Guns
~ Butter'

Characteristics of PPF
The two basic characteristicsor features of PPF are:
1. PPF slopes Downwards: PPF shows all the maximum possible combination of
two goods, which can be produced with the available resources and technology.
In such a case, more of onegoodcan beproducedonly by taking resourcesawayfrom the
productionof [Link] there exists an inverse relationship between change
in quantity of one commodity and change in quantity of the other commodity,
PPF slopes downwards from left to right (see Fig. 1.1).
2. PPF is Concave Shaped: PPF is concave shaped becauseof increasing marginal
opportunity costs,i.e. more and more units of one commodity are sacrificed to
gain an additional unit of another commodity.
In the given example, units of guns sacrificed keep on increasing each time to
increase production of one unit of butter. Due to increasing marginal opportunity
cost, PPF becomes more and more steep as we move from points A to G.
Technically, a curve with an outward bend is described as 'Concave to the Origin'.

Whether Economy will always operate on PPF?

It must be remembered that PPF does not show the point at which the economy will
actually operate. It only shows the maximum available possibilities, which an economy
can produce. The exact point of operation depends on how well the resources of the
economy are used. .
1. Economy will operate on PPF only when resources are fully and efficiently utilised.
2. Economy will operate at any point inside PPF if resourcesare notfully and efficiently
utilised. .
3. Economy cannot operate at any point outside PPF as it is unattainable with the
available productive capacity.
It means:
. Economy can either operate on PPF or inside PPF, known as 'Attainable
Combinations' .
. But, economy cannot operate outside PPF, known as 'Unattainable Combina-
tions' .
Introduction 1.13

Attainable and Unattainable Combinations

Let us clear the concept of 'Attainable and Unattainable Combinations' with the help
of Fig. 1.2:
y

en
18 . Any point on PPF (Points A to D)
or any point inside PPC (Point E)
'E 15 are attainable combinations.
::3
§. 12
tJ)
§ 9
. Any point outside PPF (point F)
is an unattainable combination.
(!)
6
Eo

0 2 3 4 5 6
x
. Butter (in units)

Fig. 1.2

Attainable Combinations: It refers to those combinations at which economy can

operate. There can be two attainable options:
1. Optimum utilisation of resources:If the resources are used in the best possible
manner, then economy will operate at any point (like, A, B, C or D) on PPE
2. Inefficient utilisation of resources:However, the actual production can fall short of
its capabilities. If there is wastage or inefficient utilisation of resources, then
economy will operate at any point inside the PPF (like E).
Unattainable Combinations: With the given amount of available resources, it is
impossible for the economy to produce any combination more than the given possible
combinations i.e. an economy can never operateat any point outside the PPF (like F).
For "An economy always produces on, but not y
inside, a PPF". refer HOTS. PPF and MRT

PPF and MRT

We can measure MRT on the PPF. For example
MRT between the possibilities D and E is equal ~ c 15
to DH/HE and between E and F, it is equal to .~ 12
EI/IF and so on. i::3 9
We know, PPF is concave shaped curve. The slope (!) 6
of PPF is a measure of the MRT. Since the slope of 3
a concave curve increases as we move downwards -& X :
0 2 3 4 5 6
along the curve, the MRT also rises as we move Butter (in units)
downwards along the curve. Fig. 1.3
1.14 Introductory Microeconomics

Can PPF be a straight line?

PPF can be a straight line if we assume that MRT is constant, i.e. same amount of a
commodity is sacrificed to gain an additional unit of another commodity. It is possible
only when we assume that all the resources are equally efficient in production of all
goods. In such case, PPF will be a straight line as shown in Fig. 1.4.
y y

Good Y lA Good Y IA

0
4x 0
4x
'GoodX GoodX
Fig. 1.4 Fig. 1.5

Can PPF be Convex to the Origin?

PPF can beconvex to the origin ifMRT is decreasing,i.e. less and less units of a commodity
are sacrificed to gain an additional unit of another commodity. In such case, PPF will
be a convex shaped curve as shown in Fig. 1.5.
ft must be noted that both thesesituations(i.e. PPF beinga straightline or convex
shaped)would not arise, as MRT always increases.$0, PPF is always concave
shaped.
y
PPF and Opportunity Cost PPF and Opportunity Cost
The opportunitycostof a product is the alternative 21,A
that must be given up to produce that product. 18
PPF illustrates the concept of opportunity cost. ~
.- 15
The opportunity cost of producing more butter isfewer §
guns. As we move from 'E' to 'F' (see Fig. 1.6 .~ 12
and Table 1.1), the production of butter rises from ~ 9
4 units to 5 units, but the number of guns 6
decreases from 11 unitE to 6 units, Le. opportunity 3
X
cost of the 5th unit of butter is sacrifice of 5 units 01,":
0123456 ~: \G
of guns. Butter(in units)
PPF as Transformation Curve Fig. 1.6
Slope of PPF indicates the ease or difficulty in transforming one good into another.
In the given example (Table 1.1), when we move down the curve, we transform guns
into butter, and when we move up, we transform butter into guns. Because of this
reason, PPF is known as "Transformation Curve."
Introduction 1.15

Change in PPF
PPF is based on the assumption, that resources of an economy are fixed. However, in
this changing world, the productive capacity of an economy is constantly changing
due to increase or decrease in resources. Such changes in resource lead to change in
PPF. The change in PPF indicates either an increase or a decrease in the productive capacity of
the economy.
The change in PPF can be of two types:
1. Shift in PPF: PPF will shift when there is change in productive capacity (resources
or technology) with respect to both the goods.
2. Rotation of PPF: PPF will rotate when there is change in productive capacity
(resources or technology) with respect to only one good.
1. Shift in PPF
The PPF can shift either towards right or towards left,when there is change in resources
or technology with respect to both the goods.
(i) Rightward Shift in PPF: When there is advancement of technology or/ and
increase in availability of resources in respect to both the goods, then PPF will
shift to the right. For example, if there is increase in resources for production of
butter and guns, we can produce more of both the goods. In such case, existing
PPF (PP) will shift to the right, represented by PIPI in Fig. 1.7.
y
Rightward Shift in PPF

P11 ----
P

2' PPF shifts to the right from PP to P 1P 1

'2: when there is increase in resources
::J orland technological upgradation of both
:§.. guns and butter.
'"
c:
::J
C>

. X
0 P P1
Butter (in units)
Fig. 1.7

(ii) Leftward Shift in PPF: PPF will shift towards left, when there is a technological
degradation and/or decrease in resources with respect to both the goods. For
example, destruction of resources in an earthquake will reduce the productive
capacity and as a result, PPF will shift to the left from PP to PIP I (Fig. 1.8).
For, "HowPPF willbe affectedby massiveunemploymenf',refer HOTS.
2. Rotation of PPF
It happens when there is change in productive capacity (resources or technology)
1.16 Introductory Microeconomics

with respect to only one good. The rotation can be either for the commodity on the X-
axis or for commodity on the Y-axis.
y Leftward Shift in PPF
p
PPF shifts to the left from
PP to P 1P 1when there is
decrease in resources
orland technological
degradation of both
guns and butter.

0 p1 p .x
Butter (in units)
Fig; 1.8

(i) Rotation for commodity on the X-axis: When there is a technological

improvement or an increase in resources for production of the commodity on
the X-axis (say, butter), then PPF will rotate from AB to AC.
However, in case of technological degradation or decrease in resources for
production of butter, then PPF will rotate to the left from AB to AD (Fig. 1.9).
y y
Rotation for Commodity
Rotation for Commodity on the Y-axis
on the X-axis
c.--,
AL /'1i'
.
, ',rotation
Rightward
£i" '~""
(j)
';: := D /
:J § --,f>
§. .!: ---.
';;; Leftward -.,. . .
~
In '
C
:J
(!)
:""'\
.. \ ,
c
:J rotation ., '
(!) '-:.
. .. Rightward
Leftwardrotation.."""'V" . .rotation x
0 D B c x 0 B
Butter (in units) Butter (in units)
Fig. 1.9 Fig. 1.10

(ii) Rotation for commodity on the Y-axis: A technological improvement or an

increase in resources for production of commodity on Y-axis (say, guns), will
rotate the PPF from AB to CB.
However, in case of degradation in technology or a decrease in resources for
production of guns, will rotate the PPF to the left from AB to DB as shown in
Fig. 1.10.
Introduction 1.17

Overview of PPF
Let us quickly revise the concept of PPF with the help of Fig. 1.11:

P,r---___-- E. Unattainable
P L A --, Point
>-
i-
"0
0
P, I
'
'
E Inward ",
E ! shift ',
0 '
()
D
Underutilisation
of resources
.
0
x
P, P P,
Commodity- X

Fig. 1.11

1. PPF slopes downwards, as an increase in production of one good requires

decrease in production of the other.
2. PPF is concave shaped due to increasing MOC.
3. PPF shows transformation of one good into another, not physically, but by
diverting resources from one use to the other.
4. PPF shows the maximum available possibilities. The exact point of operation
depends on how well the resources of the economy are used.
5. If the economy operates on PPF (like points A, B or C), it means resources are
fully and efficiently utilised.
6. If the economy operates at any point inside PPF (like point 'D'), it means resources
are not,fully and efficiently utilised.
7. Economy cannot operate at any point outside PPF (like point 'E'), as it is
unattainable with the available productive capacity.
8. An outward shift in PPF from PP to P1P1means, that the economy can produce
more of both the commodities, which was not possible earlier.
9. An inward shift in PPF from PP to P2P2means, that the economy's capacity to
produce both the commodities has reduced.
Refer Power Booster for "Solution of Central Problems through PPF".
1.18 Introductory Microeconomics

1.9 SOLVED PRACTICALS

Practicals on Opportunity Cost

Example 1. Deepak is working as a sales manager at a salary of Rs. 1,00,000 per
month. He received 2 more job offers. He got an offer of Rs. 70,000 from Reliance
Industry and offer of Rs. 85,000 from Tata Industry. What is his opportunity cost for
working as a sales manager?
Solution:
In the given case, the next best offer for Deepak is that of Rs. 85,000 from Tata
Industry. So, the opportunity cost of Deepak for working as a sales manager is
Rs. 85,000.

Example 2. A farmer produces 100 kg of wheat on a piece of land with the help of a
given quantity of resources. If this farmer can also' produce 70 kg of rice with the
same quantity of resources, then what is the opportunity cost of producing wheat?
Solution:
The opportunitycost of producingwheatis 70 kg of rice.

Practicals on PPF
Example 3. Calculate the marginal opportunity cost (MOC)of commodity A for the
given combinations:
Commodity A 0 1 2 3' 4 5

Commodity B 15 14 12 9 5 0
,/
Solution:
Commodity A 0 1 2 3 4 5
Commodity B 15 14 12 9 5 0
MOC - 1 2 3 4 5

Example 4. Determine the marginal opportunity cost from the following data:
Commodity A Commodity B
20 10
10 14
Solution:
Commodity A Commodity B MOC
MOC = Units Sacrificed = A
Units Gained B

20 10 -
I
10 14 10 = 2.5
4
Introduction 1.19

Example 5. Compute marginal opportunity cost (MOC) from the following data:

[ Good
Good Y
X I
200
0 I
180
10 I
140
20 I
80
30 I
0
40 J

Solution:
Good X Good Y MOC
Units Sacrificed Y
MOC=
Units Gained =L\)(

0 200 -
10 180 20 =2
10

20 140 40 =4
10

30 80 60 = 6
10

40 0 80 =8
10

Example 6. The following table depicts the production possibilities of commodities

X and Y:
Possibility A B C D E

Commodity X 0 1 2 3 4

Commodity Y 10 9 7 4 0

(a) Show these production possibilities through PPF. What do the points on the
curve indicate?
(b) Label a point F inside the curve. What does this point indicate?
(c) Label a point G outside the curve. What does this point indicate?
(d) What must occur so that the economy can attain the level of production as
indicated by point G.
Solution:
(a) The given diagram shows all the production possibilities given in the table.
Points on the curve (A to E) indicate that there is fuller utilization of resources;
(b) Point F inside the curve indicates Y
underutilization of resources; °G(Unattainable Combination)
(c) Point G outside the curve indicates an >-
unattainable combination; :~
-0 8
(d) Economy can attain the level of production ~6
as indicated by point G, only when there 8 4 of
(Underutilization
is an increase in resources or an 2 of resources)
. . \E X
improvement in technology with respect 0 234 5
to both commodities X and Y. Commodity X
Fig. 1.12
1.20 Introductory Microeconomics

Example 7. A country produces two commodities: X and Y. Its production possibilities

are shown in the following table:
Possibility A B C D E F
Commodity Y 20 14 9 5 2 0

Commodity X 0 1 2 3 4 5

a. Calculate marginal rate of transformation (MRT);

b. Construct a PPF with the help of the various possibilities;
c. Comment on the shape of PPF along with its reason.
Solution:
(a)
Possibility A B C D E F

Commodity Y 20 14 9 5 2 0

Commodity X 0 1 2 3 4 5
MRT - 6:1 5:1 4:1 3:1 2:1

(b)
y

4
x
0 2 3 4 5
Commodity X

Fig. 1.13
(C) PPF is convex shaped due to decreasing MRT, Le. less and less units of
commodity Yare sacrificed to gain an additional unit of commodity X.