Question

Economics is about scarcity,chioce and opportunity cost.with aid of a diagrams using a production possibility frontier,explain theses and also highlight the importance of this model in understanding economics. use citation of refertences using harvard way of writing.

Answer 1

Economics is about making choices to use scarce resources in order to provide people with goods and services in the best possible manner. These choices are made on the basis of opportunity costs. Opportunity cost refers to the amount of what needs to be foregone in order to get something else or to produce some particular good or service. Basically it is the cost of next best alternative foregone.

These concepts of scarcity, choice and opportunity cost can be understood through production possibility frontier. Production possibility frontier refers to the graphical representation of all possible combinations of two goods which can be produced using given resources and given technology.

This is a PPF of good X and good Y with good X on X axis and good Y on Y axis.

Since the resources are scarce and given so only a limited quantity of both the goods can be produced using all the available resources. There are various combinations of these goods which can be produced using these scarce resources and the economy has to choice to decide which combination it needs to produce.

Producing more of one good means that less of the other good needs to be produced as resources are scarce and fixed. The quantity by which production of one good can be increased by decreasing the production of other good will depend upon the opportunity cost.

To understand it better, let's analyse the above diagram. All the points on the PPF like A, B, C, D, E, F, G show those combinations of the two goods which can be produced by using all the available resources efficiently using the given technology. It is the scarcity of resources due to which the economy can produce only on or within this PPF and not outside it. It is economy's choice to produce either inside this PPF or on any of the points on this PPF. Points inside the PPF are inefficient points as they do not make use of all the available resources. Points on the PPF are efficient combinations. While all points outside this PPF are unattainable combinations as they can't be produced using the given resources.

Opportunity cost depends on where exactly we are on the PPF currently. For example, if the economy is initially producing at point A, then it is producing 21 units of good Y and 0 units of good X. If now it decides to produce at point B, then it will produce 18 units of good Y and 1 unit of good X, so in order to increase the production of good X by 1 unit, the economy has to decrease the production of good Y by 3 units, so opportunity cost of X in terms of Y is 3.

As we go down the PPF from point E to point F, the production of X increases by 1 unit while production of Y decreases by almost 5 units, so the opportunity cost to produce X has increased.

Opportunity cost of producing more units of good X is fewer units of good Y. As we go down the PPF, the opportunity cost of good X in terms of good Y keeps on increasing i.e. as more and more units of good X are produced, higher and higher units of good Y need to be sacrificed in order to increase production of good X by 1 unit.

Opportunity cost is the number of units of one good that need to be sacrificed to gain one additional unit of the other good. This can be very easily calculated through the diagram of PPF.

Uses of PPF to understand economics :

Production possibility frontier helps to understand the concepts of opportunity costs and tradeoffs as shown in the above diagram.

It helps to illustrate economic growth. Economic growth is associated with increase in the availability of all resources in the economy which leads to a parallel outward shift of the PPF showing that more quantity of all goods can be produced in the economy using the available resources. It is represented by the pink rightward curve in the diagram below. If there is degradation of resources which might be due to depletion of technology or damage to resources due to natural disasters, then there is a loss of all resources in the economy due to which the PPF shifts inwards showing that lesser quantity of all goods can be produced now with the available resources and technology. It is represented by the pink leftward curve in the below diagram.

Any change in the technology of production related to production of one good can also be shown through PPF. It leads to a pivotal rotation of the PPF on the axis of the good for which the technology has changed. If the technology of production of good X has improved, then there will be outward pivotal rotation of the PPF in favour of good X as now more units of good X can be produced using the given resources.

PPF also helps to understand the law of diminishing returns.

PPF also helps to access the point at which an economy can reach if it uses all it's available resources efficiently. It is a very important tool for decision making for producers as it helps them to attain an efficient mix of the two goods.

PPF also helps to take trading decisions based on absolute and comparative advantage.

Therefore, PPF serves as a very important tool in understanding the broader concepts of evonomics, and decision making in times of scarcity.