SHAPE OF PRODUCTION POSSIBILITY CURVE:

Shape 1: Concave
Good Y
A P



Q

0 Good X
B
The slope of the production possibility curve is the Marginal Rate of Transforation !MRT"
#hich indicates the rate at #hich one good is being transfored into another$ not physically$ but by
transferring resources fro one good to another good% As #e ove along the production possibility
curve through points P and Q do#n#ards$ slope or steepness of each tangent through these points
increases% Thus$ the production possibility curve ta&es a concave shape$ indicating increasing
opportunity cost$ that is$ the econoy is #illing to give up ore Y for an additional unit of X% There is
increasing opportunity cost because of diinishing returns%
'ote( slope of PP) * MRT
YX
* change in Y * opportunity cost of producing an additional unit of X in
change in X ters of Y%

Shape 2: Convex
Good Y
A
P
Q
0 Good X
B
As #e ove do#n#ards fro P to Q$ the steepness of each gradient falls$ i%e$ the gradient
becoes flatter% +n other #ords$ the slope of the production possibility curve diinishes as #e ove
do#n#ards% This eans that the MRT
YX
&eeps falling$ and thus$ the opportunity cost is decreasing
!increasing returns"% The econoy is no# #illing to give up less units of Y for the sae additional unit
of X%
,
Shape 3: Linear
Good Y
A

P


Q

0 B Good X
-ere the slope of the production possibility curve reains constant% The MRT
YX
is constant or
unchanged as #e oved do#n#ards the curve fro left to right% Thus$ the production possibility curve
becoes linear or straight line% The opportunity cost also reains constant !constant returns"% This
eans that the econoy is #illing to give up the sae aount of Y for the sae additional unit of X%
SHIFT OF THE PRODUCTION POSSIBILITY CURVE : :
Good Y
A
,
A c
a

b

0 Good X
B B
,
+f the econoy.s capacity to produce goods is increasing$ the production possibility curve #ill be
oving out#ards over tie% This indicates that econoic gro#th has ta&en place% /conoic gro#th
shifts the boundary out#ard and a&es it possible to produce ore of all goods% Before gro#th points a
and b #ere on the production possibility curve and point c #as unattainable% After gro#th$ point c is
attainable%
FACTORS RESPONSIBLE FOR THE SHIFT:
,% +proveent in the state of technology
0% +ncrease in the labour force and labour productivity
0
1% +ncrease in capital stoc& !investent"
2% 3iscovery of ne# resources%
PRODUCTION POSSIBILITY CURVE AND EXCHANGE (th!"#h $%te%at$!%a&
ta'e(:
Good Y
A

00 P !,0X$ 00Y"


,4 Q !00X$ ,4Y"

0 Good X
,0 00 B
+n an open econoy$ suppose a country produces at point P along the production possibility
curve AB% +n other #ords$ #ith the available aount of resources$ it produces ,0 units of X and 00 units
of Y% )obination Q cannot be produced due to scarcity of resources unless there is econoic gro#th%
-o#ever$ even #ithout econoic gro#th$ consuption at point Q could be attained only through
e5change$ that is$ only if the country engages itself in international trade% To attain cobination Q$ the
country has to e5port 2Y and iport ,0X%
ECONO)IC SYSTE)S: ECONO)IC SYSTE)S:
The central proble of every econoic society is to allocate resources in deciding #hat$ ho#$
and for #ho to produce% These three 6uestions are dealt #ith in different #ays in each and every
1
econoy% They are dealt #ith depending on the econoic and political frae#or&s of that country%
Broadly spea&ing$ the econoic systes are classified into 1 categories naely(
,% The ar&et econoy or laisse78faire syste or capitalist econoy%
0% The coand or planned econoy
1% The i5ed econoy%
)AR*ET ECONO)Y:
+n a ar&et econoy resource allocation is carried out by private individuals only% All factors
of production are privately o#ned and anaged% There is no governent intervention and everyone is
free to operate according to his #ill and desire% The ain characteristics of such a syste are(
1+ Price9 ar&et echanis #hich anipulates the allocation of resources or tries to resolve the
three fundaental 6uestions of #hat$ ho# and for #ho to produce% +n other #ords$ resources are
allocated through changes in relative prices% Ada :ith referred to it as the ;invisible hands< of the
ar&et%
2+ )onsuer.s sovereignty e5ists$ that is$ consuer is a &ing because it directs the allocation of
resources to a large e5tent #hile satisfying its o#n needs% -is basic ai is to a5iise satisfaction%
The consuer.s decision can dictate econoic actions as #hat and ho# to produce%
3+ Producers ai at profit a5iisation and rely on higher prices as a ;green signal< to higher
production% The foundation is the profit otive% /vidently$ the production of those coodities #ill be
ore profitable #hich are deanded ore by consuers%
,+ =ierce copetition aong firs e5ists and basically it is this copetition #hich encourages
technological change$ innovation and higher investent%
-+ /asy obili7ation of capital due to profit a5iisation and regular innovations% >bviously$
these do encourage industriali7ation and econoic developent%
ADVANTAGES OF )AR*ET ECONO)Y:
1+ There is consuer sovereignty% This eans that consuers can influence #hat goods are
produced directly by their purchase% +n fact$ they are free to buy #hatever goods and services fro
2
#hich they can derive a5iu satisfaction% :iilarly$ the greater use of price echanis #ill provide
an autoatic and 6uic& #ay to signal to producers #hat consuers #ant%
2+ The ar&et provides a #ide variety of goods and services to eet consuer.s #ants% +ndeed$ the
consuers ay have a greater choice of a nuber of private8sector producers% This increased
copetition ay increase the 6uality of products since rival producers #ill see& to attract ne# custoers
by iproving the standard of their goods%
3+ The ar&et syste provides incentives to producers in the for of profits and #or&ers in the
for of higher #ages% This should encourage entrepreneurs to produce high 6uality products and to
innovate$ and #or&ers to #or& hard%
,+ There is greater efficiency% The ai of firs in a ar&et econoy is to a&e a5iu profit%
-ence$ the ar&et syste encourages technological change$ that is$ the use of ne# and better ethods
and achines to produce goods and services at lo# cost% Those firs$ #hich do not produce #hat
people #ant at lo# cost and lo# prices$ ay go out of business%
)AR*ET FAILURES . I)PERFECTIONS:
+n theory the price echanis can go a long #ay in efficiently and autoatically solving the
basic econoic probles% -o#ever$ in practice it fails in any respects% There are any ar&et
failures such that the price syste cannot ensure the best use of scarce resources(
1+ N! p!/$0$!% 1! p"2&$3 #!!'0 ! p"2&$3 "t$&$t$e0:
Public goods are goods produced on a non8profit a5iisation basis because they !street8
lighting$ defence$ roads" ai at a5iising socio8econoic #elfare% Thus$ they cannot be produced
through the ar&et% There is no possibility of fi5ing a price for the product in 6uestion and hence no
possibility of a&ing a profit%
2+ D$/e#e%3e 2et4ee% 0!3$a& 3!0t a%' p$/ate 3!0t:
Private cost refers to the cost #hich is incurred in the production of a certain coodity$ for
e5aple$ labour cost or cost of ra# aterials% -o#ever$ #hen production process ta&es place$ there are
so&es #hich coe fro factory chineys$ and garbage or #astes thro#n in rivers$ thereby$ creating
?
pollution% /conoists evaluate these costs and nae the as e5ternal costs or negative e5ternalities%
These e5ternal costs are never considered by a private producer in a ar&et econoy% This eans that
nothing uch is done to reduce pollution and any other destruction caused to nature%
3+ Ha51"& p!'"3t0 5a6 2e p!'"3e' a%' 3!%0"5e':
The absence of a governent sector iplies the absence of ta5es and the free operation of the
ar&et echanis% @eft to the price syste$ there #ill be overproduction of certain harful products
such as drugs$ alcoholic drin&s and cigarettes% Their high prices initiate higher production and greater
infiltration of these harful goods #hich greatly affect the peaceful life%
,+ L"7"$e0 $% p&a3e !1 %e3e00$t$e0:
:ince allocation of resources depends greatly on those goods #hose prices are high or are
rising$ obviously$ the private producers #ill produce ore of these goods and less of other goods ay
be essential products% Thus$ a rise in the deand of cars ay encourage producers to produce ore cars
and less food #hich is but an irrational allocation of resources% The syste broadly indicates that only
the rich people have the greater say through their e5penditure patterns and the poor$ on the hand$
reain poor%
-+ U%e8"a& 4ea&th '$0t$2"t$!% . $%e8"a&$t$e0 !1 $%3!5e:
+ndeed$ the laisse78faire capitalis a&es the rich richer and the poor poorer% :ysteatic
e5ploitation by the capitalists of the poor #or&ing class is obvious because they have to a5iise
returns and iniise costs$ essentially labour costs% The labour cost has to operate at lo# rates and be
very productive in the production process% +n this case$ the #ealth distribution under this syste can
never be reduced%
9+ Pe0"a0$/e a'/et$0$%#:
>#ing to the fierce copetition #hich e5ists aong firs in a pure ar&et syste$ huge
e5penses are ade annually on advertising% The advertising #hich is adopted is eant for product
differentiation% :uch e5penses are usually against custoers. interests because they are not only
4
isleading$ but also #asteful% Resources used in advertising could have been used soe#here else for
ore productive purposes%

:+ C63&$3a& 1&"3t"at$!%0:
)yclical fluctuations are caused by the ever8changing deand and supply conditions%
:oeties$ #hen producers anticipate a rise in deand for certain goods$ they raise investent to
produce ore% But if deand actually does not rise$ a general glut #ill occur$ that is$ stoc&
accuulation% )onse6uently$ the affected producers #ill have to reduce investent$ disiss #or&ers to
reduce costs% Both of these have an adverse effect in the econoy as a #hole% @ess investent eans
lo#er production #hile lo#er eployent eans less consuption$ lo#er prices and profits% These
cuulative effects lead to a lo#er national incoe%
+t can be deduced that price echanis deterines allocation of resources as per #hat
consuers #ant ore #hich initially sounds right% -o#ever$ this syste cannot be left to itself because
of its various iperfections #hich undoubtedly necessitate governent intervention%
PLANNED ECONO)Y:
A planned econoy is the direct opposite of the ar&et econoy% -ere all the resources are
o#ned by the governent or the public sector #hich is the central body deciding upon the allocation of
resources% This allocation is ho#ever e5erted on the follo#ing grounds(
Ma5iising socio8econoic #elfare through creation of public utilities%
'on8profit a5iising strategy%
Parliaentary decisions%
-o#ever$ in real #orld$ coand econoies seldo e5ist% )entral planners ay set the prices
of essential consuer goods$ and allo# factory anagers to set prices of less essential goods% -o#ever$
such an econoic syste has got several deerits #hich can be discussed as follo#s(
1+ De3$0$!%0 ae 2a0e' !% a pa&$a5e%ta6 &e/e&:
:ince decisions are based on parliaentary level$ they are not readily ipleented and in this
#ay$ several iportant decisions concerning socio8econoic activities ay be delayed%
A
2+ I%e11$3$e%36:
A coon feature against the public sector is inefficiency and lac& of copetence% The sector
is generally over8staffed and inefficient% The services are of ;Red8Tape< type because of high level of
bureaucracy% +n addition$ the attitude of a secured Bob in the governent sector a&es #or&ers idle and
careless about the 6uality of services to be provided to the ebers of the public%
3+ ;a0te !1 e0!"3e0:
Cery often there is #astage of resources especially #hen public sector e5penditure is analysed%
There is a great abuse on the part of the #or&ers concerning the use of public sector resources and
aterials%
,+ The a20e%3e !1 3!5pet$t$!%:
The absence of copetition in this econoic syste does not ensure innovation and constant
iproveents in the 6uality and 6uantity of products% >#ing to the principle of ;'o profit8 'o loss<$
huge losses have to be borne at ties by the public sector% Therefore$ it is difficult to find out additional
resources for innovations%
-+ Re0t$3t$!% !% 3!%0"5e0< 0!/ee$#%t6:
:ince there is central allocation of resources$ consuers ay deand #hat they #ish but to a
restricted e5tent% The production of lu5uries is given as the ultiate priority by the governent because
of the concept of the #elfare state% Priority ust be given only to the production of the ost essential
products in the society%
)IXED ECONO)Y:
+n a i5ed econoic syste$ resource allocation is influenced both by the private and public
sectors% +n other #ords$ in such an econoic syste$ soe econoic decisions are ta&en by the ar&et
echanis and soe by the governent planning% +t has been found that all odern econoies are
no#$ to varying e5tent$ i5ed in nature% Many nations have fluttered fro socialis in the course of
D
tie so uch so that they have ebraced the ter i5ed econoy% Recent developents have
suggested the superiority of ar&et over planned econoies% =or instance$ the collapse of counis
in Russia and /astern /urope in late ,ED0s had proved the deise of planning due to ineffective
resources allocation% >n the other hand$ predoinantly capitalist nations such as F:A allo#ed
governent to ta&e soe econoic decisions% Thus$ in a i5ed econoy the price syste allocates
resources$ but on account of ar&et failures$ there is the need for governent intervention% +n fact$ the
governent has to intervene in order to attain soe iportant icro and acro econoic obBectives%
R!&e !1 #!/e%5e%t p&a%%$%# $% a 5$7e' e3!%!56:
1+ +n a odern i5ed econoy$ the governent has to intervene to change the #rong cobination
of goods% +f left to the price syste$ there #ill be over8production and over8consuption of deerit
goods li&e drugs$ cigarettes and alcohol% -ence$ the governent has to discourage consuption of
these deerit goods through ta5ation%
2+ The governent has to provide public goods in a odern i5ed econoy since provisions of
these goods are difficult and unsuitable in the hands of private sectors% 3efence$ roads$ street8lightning
are provided by the state in every odern i5ed econoy% Mar&et syste cannot copel payent for
public goods since there is no #ay to prevent a person #ho refuses to pay for the good fro receiving
its services% Thus$ the private firs #ill fail to produce these goods% The governent$ by virtue of their
po#er to ta5$ can provide the services and collect fro everyone%
3+ +n a vie# to a5iising profits$ private firs consider only their private costs and private
benefits% They ignore any e5ternal costs and benefits incurred in the production process% Thus$ firs
tend to produce ore of those goods #hich cause e5ternal costs !pollution"$ but less of those goods
#hich cause e5ternal benefits% As a result$ the governent intervention is deeed necessary to correct
the e5ternality by a&ing rules and regulations% The governent should subsidise activities #hich
cause e5ternal benefits$ #hile ipose ta5ation to reduce e5ternal costs%
,+ Most governent in odern i5ed econoy have policies designed to discourage firs to act
as onopoly% +n any countries$ iportant legislations are passed to regulate e5isting onopolies and
prevent inforal agreeents #ith the ain ai of a&ing profits by e5ploiting consuers%
E
-+ Governent ay ai to proote the general econoic #elfare of the population by creating a
ore e6uitable distribution of incoe and #ealth% They ay ai to achieve this by a syste of
progressive ta5ation$ subsidies and transfer payents%
9+ Governents have a large nuber of acro8econoic policy instruents #hich they use to
influence$ for e5aple$ the level of spending$ the aount of investent$ level of eployent$ rate of
inflation and international trade position% Their ai is to ensure a steady rise in output and
iproveents in living standards%
ROLE OF PRIVATE SECTOR IN A )IXED ECONO)Y:
1+ Greater copetition in the private sector otivates innovations and iproveents in the 6uality
of goods and services provided by the public sector%
2+ Profits ay be used as a guide to efficient allocation and this tends to raise copetition and
encourage industrialisation%
POSITIVE AND NOR)ATIVE STATE)ENTS: POSITIVE AND NOR)ATIVE STATE)ENTS:
+t is iportant to distinguish in the study of econoics t#o types of stateents representing the
ethodology or approach in the schee of analysis% These stateents are positive and norative%
,0
Positive stateents deal #ith facts #hich had already been e5perienced% +n addition$ they are
concerned about #hat is$ #as or #ill be% The evolution of life and the society is dynaic and several
e5periences are encountered and it is ;positive stateents< #hich #ould analyse these e5periences%
>n the other hand$ norative stateents depend on our value Budgeents$ i%e$ #hat is good or
bad and ho# things should be% Ghat #e #ant to happen and #hat really happens are t#o different
issues% Ghat #e #ant to happen is norative and #hat really happens is positive%
=or e5aple$ ;#hat policies #ill reduce uneployentH< and ;#hat policies #ill prevent
inflationH< are positive ones$ #hile the 6uestion ;>ught #e to be ore concerned about uneployent
than about inflationH< is a norative one%
The stateent ;A ore e6ual distribution of incoe #ould increase national #elfare< is a norative
stateent$ #hile ;An increase in governent spending #ill reduce uneployent and increase
inflation< is a positive one%
IIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIII
FUNCTIONS OF )ONEY:
Money ust perfor the follo#ing functions to overcoe the probles #ith barter%
1+ )!%e6 5"0t a3t a0 a 5e'$"5 !1 e73ha%#e+ This eans that oney allo#s buying and selling
to run efficiently% An individual can sell his labour service and uses the oney to buy other #ants%
2+ )!%e6 a3t0 a0 a 5ea0"e !1 /a&"e+ This eans that the value of all goods and services are
e5pressed in ters of oney% )onsuers are able to copare the value of different goods% :iilarly$
businessen &eep record of their transactions in fors of oney%
3+ )!%e6 5"0t a3t a0 a 0t!e !1 /a&"e+ This eans that ebers of the public can hold their
#ealth in ters of oney% An individual can save his oney in the ban& and use it in the future to buy
goods and services%
,+ )!%e6 5"0t a3t a0 a 0ta%'a' !1 'e1ee' pa65e%t+ This eans that credit transactions and hire
purchase can ta&e place% People can ac6uire goods and services no# and payent can be ade later%
IIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIII
SPECIALI=ATION . DIVISION OF LABOUR SPECIALI=ATION . DIVISION OF LABOUR: :
:peciali7ation eans concentration of factors of production in one particular tas& in #hich they
are best suited% A counity #hich practise speciali7ation is able to produce ore than enough goods
than they need% The increased production achieved by speciali7ation is the result of the division of
,,
labour% 3ivision of labour eans that each #or&er concentrates on one Bob he is best able to do and
relies on the #or& of others to supply ost of his needs% +n other #ords$ #ith division of labour people
need to e5change or trade in order to obtain a variety of goods and services to satisfy their #ants%
3ivision of labour also eans the splitting or the brea&ing up of the #hole production process into
several processes #here each process is perfored by one #or&er or a group of #or&ers #ho becoe
specialist% 3ivision of labour can also be aong nations #hich eans that countries$ or areas #ithin
countries$ speciali7e in certain &inds of products !coparative advantage"%
ADVANTAGES OF DIVISION OF LABOUR:
1+ )!e #!!'0 a%' 0e/$3e0 3a% 2e p!'"3e':
Ghen #or&ers becoe specialists in the Bob they do$ repetition of the sae operation increases
the s&ill and speed of the #or&er% As a result$ ore is produced% 3ivision of labour enables ass
production to ta&e place%
2+ )a7$5"5 "0e !1 the 4!>e<0 a2$&$t6:
Gith the division of labour there is greater chance that people #ill be able to do those things at
#hich they are best and #hich interest the the ost% -ence$ there is iproveent in s&ills%
3+ T$5e $0 0a/e':
Tie is saved because #or&ers do not have to ove fro one operation to another% Tie is also
saved #hen training people% A #or&er can be trained very 6uic&ly for the perforance of a single
operation%
,+ It a&&!40 the "0e !1 5a3h$%e6:
As labour is divided up into specialist tas&s$ it becoes #orth#hile to use achinery #hich
allo#s a further saving in tie and effort% +n fact$ division of labour enables the use of ore siple
achines%
DISADVANTAGES OF DIVISION OF LABOUR:
1+ ;!> 5a6 2e3!5e 2!$%#:
A #or&er #ho perfors the sae operation each and every day is li&ely to becoe very bored
and dissatisfied% This ay lead to increased absenteeis and reduced productivity%
2+ L!0t !1 3a1t05a%0h$p: Ghen industry applies division of labour$ there is a loss in craftsanship%
3ivision of labour has led to an increase use of achinery% Thus$ the basic s&ills have no# been
,0
transferred fro the hands of the #or&ers to achines% +t is the achines #hich no# control the design
and 6uality of the goods%
3+ ;!>e0 2e3!5e t!! 'epe%'e%t "p!% ea3h !the:
:peciali7ation and division of labour eans that people coe to rely on others for the provision
of goods and services% This illustrates that in any industries$ #or&ers have becoe dependent on the
actions of other #or&ers% =or instance$ if there are several processes in the production of an article$ a
stri&e aong one group of #or&ers can 6uic&ly affect those engaged in other processes%
,+ L$5$te' >%!4&e'#e:
3ivision of labour has caused #or&ers to have liited &no#ledge% The #or&ers only get to &no#
one Bob% They do not have the #ide training #hich #ould a&e the adaptable to changes in the
techni6ues of production% Thus$ should there be a decline in the deand for their particular s&ills$ the
#or&ers find it difficult to transfer to other occupations% These #or&ers #ill$ therefore$ be uneployed%
-+ P!'"3t0 ae a&& the 0a5e:
The goods produced under a syste of speciali7ation are usually turned out in vast nubers and
share the sae design% +n other #ords$ they are standardi7ed% +t is not possible to please everyone
because it #ould be difficult and e5pensive to change the production process to suit one person.s
#ishes%
,1



,2