This article talks about Economy, about Microeconomics & Macroeconomics, and subtopics like production possibility frontier. also learn . Let’s begin.
What is an Economy
Society consists of people and people in the society need many goods and services in their everyday life including food, clothing, shelter, transport facilities like roads, railways and various other services like that of teachers and doctors.
A society is made up of people and they need various goods and services in their day to day life like transport, clothes, foods, etc. People also need services like health care, education, entertainment etc.
People in society can work and earn money (limited). The income which they have enables them to buy and consume various goods and services(which can be unlimited).
Basically, everyone gives something to society like they can be a software engineer and work on websites for companies. This entitles them for remuneration and that helps them to buy things they need.
So, the economy is a system which enables people to get work and earn.
Economics is studying various factors of an economy and problems which arises due to limited resources and unlimited needs.
Economics :
In daily life, you must have applied basic economics while going out on dinner with friends or organizing a small party at home as you have a budget which under which have to work it out. This is simple decision making to come purchase limited things from limited resources is simply Economics.
Economics primarily deals with the production, distribution, and consumption of goods and services.
Further economics focus on these four factors of production :
- Land
- Labor
- Capital
- Enterprises
As mentioned above, economics is consists of studying scarcity. Let’s take a look at the concept of scarcity.
Scarcity
There are limited resources and unlimited needs of goods and services. There is always a gap between demand and supply. When there is a lack of resources then it is referred to as “scarcity” in economics.
Economizing of Resource: The best optimum use of the input resources to get maximum output.
Main Problems of an Economy :
The basic problem of an economy is choosing an option among various resources.
There are other problems too of an economy but here I will explain the main problem i.e. ‘Problem of allocation of resources’.
Economy has a scarcity of resources which can be employed to manufacture or produce different goods and services. Therefore, the ideal way to allocate limited resource is to produce goods and service in a way it meets the demands & needs of society.
The decision for the optimal allocation of resources requires to consider the following three parameters:
- What goods & services to produce?
- How to produce goods & services?
- Whom to produce goods and services for?
Let’s begin with digging a little deeper into these parameters.
What goods & services to produce?
Every economy needs to ascertain that which are the things needs to be produced and manufactured and in what quantity for the society.
A society has limited resources like land, labor, capital, and enterprise so it is important to analyze which commodities should be produced and what should be the priority. If the resources are allocated in an uneven manner to produce A commodity then the production of B commodity will suffer.
There are various goods like
| Sr No | Goods | Example |
| 1 | Basic necessities of life | food, clothing, housing |
| 2 | Consumer goods | Wheat flour, beans, etc |
| 3 | Civil goods | Radio, watch, etc |
| 4 | Capital goods | Machines like CNC machine, Industrial tools, etc |
| 5 | Military Goods | Fighter jets, artillery, tanks, surveillance technology etc |
| 6 | Luxury goods | Mobile phones, Automobiles, LCD, dishwasher etc |
When we have such diversified things under the sun to produce it becomes difficult to ascertain, prioritize and allocate resources.
Optimal allocation of resources in a way to give maximum utility aggregate to society is the leading principle.
How to produce goods & services?
There are different ways to produce goods and services & this problem refers to choosing one of the ways. By ‘ways’ or ‘techniques’, we mean which combination of inputs will bring optimal outputs. These techniques are broadly classified as:
- Labour Intensive techniques, more labor is employed and it is less capital intensive. Capital is not invested to buy machines.
- Capital Intensive techniques, where money is invested to buy machines and more automation is used to produce. It is less dependent on labor.
Let’s take the example of packed food, it is being produced manually by labor and also processed on large scale by machines. Implementation of technique depends on the availability of various factors and their prices. Techniques are chosen in a way that it provides employment to everyone in the economy and raise their standard of living.
In developing countries like India, China, Bangladesh generally labor-intensive techniques are employed quite cheap and is in abundance. Whereas developed countries like Germany, USA employs capital intensive techniques as there is a lack of labor and the countries are rich.
The guiding principle of ‘How to produce goods and services’ is combining different ways of production in a manner that it gives maximum output by keeping the input cost minimum and also using less scarce resources.
Whom to produce goods and services for?
Ultimately the capital goods, civil goods, and various other goods will be produced by people in society. This problem deals with the selection of the category of people in society who will buy and consume these products.
As the resources are limited, satisfying all wants of the people of a society is not possible. This creates a problem of choice.
Goods are produced for the consumers who can buy it and have paying capacity for it. People have different earnings and thus have varying capacity to buy a product. Thus, the problem is also about the distribution of income who produce the goods ie land, labor, capital and enterprise, these factors contribute to the production process.
This problem can be categorized as follows:
- Personal Distribution:
This deals with how the national income of an economy is distributed among various groups of people. - Functional Distribution:
It deals with deciding the percentage of different factors of production in the total national product of the country.
The guiding principle of ‘For whom to produce’ is safeguarding the urgent needs of all productive factors are met to the maximum degree.
Production possibility frontier and opportunity cost:
Production possibility frontier
It is a curve which represents a possible set of combination for production of two goods by providing resources and technology available in an economy.
Following assumptions are taken for Production Possibility (PP) Curve :
- Total resources in an economy are fixed.
- The technology is given and not changed.
- The resources are fully efficient and employed.
- All the given resources are not equally efficient in the production of all goods
Let’s begin with taking an example of production of two goods, rice, and tank in an economy. With this example, we will understand Production Possibility Frontier Schedule and Curve.
It will help to understand and solve the problem of what to produce and in how much quantity.
We will assume that with given resources and technology, an economy can produce only two goods, namely Rice and Tanks as shown in the production possibility schedule above.
In the above diagram, Tank is measured on the vertical axis whereas Rice is measured on the horizontal axis.
By putting all resources to produce Tanks an economy can produce OA number of tanks but the production of Rice will be zero. If on other hands an economy decides to produce rice with all its resources then it can produce OF quantity of rice, then there will be zero production of tanks. These are two extreme possible scenarios.
Apart from other two extreme possibilities there can be set of combination wherein an economy can produce some quantity of rice as well as tanks by varying the resources devoted towards them. There can be different possibilities of production as is specified by the points in the graph. By joining these points we obtain the Production Possibility Curve.
Let’s move ahead to understand full employment and underemployment by this curve.
Full Employment and Underemployment Under Production Possibility Curve
Full Employment of Resources: When the resources are fully employed it is represented along the PP-curve.
The economy has to plan that which combination of production of commodity X and Y should be done. The resources will be fully employed if production of the two commodities lies on the PP curve.
Under Utilization of Resources: Point U & I represent underutilization of the resource. Any under the curve shows the under inefficient use of resources of an economy. It shows that resources are inefficiently utilized.
Inefficient use or underutilization of resources mainly indicate two problems, problem of unemployment & inefficiency.
As the resources include labor, land, capital, and enterprises, if the labor is not employed fully for the production of good this means there is a situation of unemployment. The problem of unemployment is not limited to labor it covers other resources also.
On the other hand, if the resources are fully employed still the production lies inside the curve it means the resources are inefficient, this indicated the problem of inefficiency.
We took some assumption initially for PP curve, one of them is resources are fixed. Remember? No? Then just check it out once again.
Now few of the questions might have crossed your mind like, what if resources increases or decreases? technology changes?
Lets understand these scenarios and know how the PP curve will change.
Rightward shift of PP curve :
Every economy wants to increase resources so that it can produce more and more goods. PP curve is based on the assumption that the amount of resources is limited and fixed. When the resources increase the PP curve shift to the right and both the intercepts on the graph increases. This indicates that the production of the quantity of both goods increases.
Also, when the technology improves there is a shift in the PP curve to the right. Technology improves the efficiency of machines which helps in the production of goods. So if the technology develops there is the right shift of the curve.
Leftward shift of PP curve
When the resources of an economy decrease, the production of both the commodities decreases. As it can be clearly deferred from the above graph that the curve shifts to the left.
Cost of Opportunity Cost
When we give up ‘X’ thing to get ‘Y’ thing, the ‘X’ is called the opportunity cost of ‘Y ’ thing.
Let’s take an example if you have to produce rice instead of guns. Then the opportunity to produce gun is lost when you choose to produce rice. In this case, sacrificing the option to produce rice is the opportunity cost one has to pay to produce a gun.
Marginal opportunity cost: If one has to produce 1 unit of X commodity by sacrificing production of one or more than one unit of commodity Y, then the production of commodity Y is the marginal opportunity cost.
Let’s continue with the example mentioned above to understand it numerically.
Marginal Rate of Transformation
It is the ratio of good sacrificed to produce 1 additional unit of other good. It is calculated by below formula.
In our case, let’s consider production possibility combination E.
Amount of Guns sacrificed (thousands) = 9 – 5 = 4
Amount of Rice gained (in lakh tons) = 5 – 4 = 1
MRT = 4G/1R
So for the production of 1 lakh ton of rice the economy has to sacrifice production of 4000 guns, which is the opportunity cost of production of rice in this case.
Microeconomics: It is a study of how individual actors, like businesses and households, make decisions about pricing, saving money, purchasing, investments, competition etc. Demand and Supply are its two main instruments and microeconomics is also called as price theory.
Macroeconomics: It is a study of the economy as a whole. This involves studying various factors of an economy like national income, aggregate consumption, aggregate investment, aggregate employment, general price level, etc.
Aggregate demand and aggregate supply are its main instruments and macroeconomics are also referred to as ‘Income Theory’ or ‘Employment Theory’.
Positive and normative economics
There are many ways to solve the central problems of an economy. Any economic problem or decision can’t be taken based on one particular method. Having multiple methods provide varied solutions to any problem. These solutions help to understand the best fit for any economic problem by considering all the alternative approaches.
There are two such mechanisms which play a central role in Economics:
- Positive Economics: This mechanism considers facts and figures when the deriving solution to any problem. Past data sets, statics, and numbers are analyzed to understand the pattern of a problem and associated consequences of a decision. In this method, economists try to forecast the result and influence of a decision based on previously available data. This approach uses cause and effect relationship and objective analysis to ascertain the result. The results generated by this mechanism can be tested, demonstrated and are proved by the existing data set. Example:
- 25 major startups shut down within 5 years of their inception due to investment crunch, if government ease the loan process for a startup we expect to see fewer failures.
- If government strict the rules for issuing the driving license, it will help in decrease the accident rates in India. Almost 60% of license holders have never taken driving exams.
- Normative Economics: On the other hand, normative economics is based on a common belief system. It provides a philosophical or ideal approach to a problem. Normative economics is a subjective statement which helps to take a significant and useful judgment. Example:
- The government should take preventive measure for global warming.
- The government should decrease the income tax to improve the economy.
