AS: Unit 1 - The economic problem and the PPF

In this post we will answer 2 questions.

1. What is the economic problem?
2. What is the production possibility frontier?

What is the economic problem?

Right so lets get straight to it!

The economic problem is scarcity

Yep that is pretty much the economic problem; not so difficult right? But lets go in a bit more detail. 

Scarcity means there is only a limited amount of resources available to produce the unlimited demands of goods and services people desire. So basically in the world we live in, there are infinite 'needs' (necessities) and 'wants' (desires) and we cannot satisfy all of them, therefore we have the economic problem of scarcity.

 

SO! Basically there are 3 fundamental questions

• WHAT should we produce?
• HOW should we produce it?
• For WHOM should it be produced?

The purpose of economic activity is to increase economic welfare. Increasing production will enable economic welfare to increase (assuming production actually consumed and not just sitting around).

Here are some quick terms you'll need to know (most is probably common sense)

• Depletion - Using up scarce resources
• Degradation - e.g. Pollution and destruction of natural environment
• Consumer goods - Goods brought for consumption, e.g. food
• Capital goods - Goods brought by firms to produce other goods, e.g. machinery

The production possibility frontier (PPF)

This diagram illustrates possible combinations of product X and product Y an economy can produce when all the available economic resources are being used.

Say initially economy is producing at point A; this means at X1 output of product X, there will be Y1 output of product Y. However say the economy wants to increase output of product Y to level Y2, they cannot achieve this without decreasing the level of output of product X to X2. 

This is because the economy is operating at productive capacity, it cannot increase production of one product without decreasing production of another. This is called an opportunity cost where the loss of other alternatives when one alternative is chosen.

There are opportunity costs everywhere and you encounter them everyday. For example, you have £1 and you want to buy bottle of coke and a notebook; however you cannot afford both. You will then use a value judgement to decide which to get. Say you chose the notebook, the opportunity cost of the notebook was the bottle of coke.

The 'Guns vs Butter' model is a good example of the PPF applied.

This diagram is a fairly simple diagram, however as the course is synoptic - we can still use this diagram in A2 economics as well (as a low level diagram) so it is good to remember!

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Please leave feedback and any questions. Thank you! xx