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Chapter 2: THE ECONOMIC PROBLEM Powered By Docstoc
					   Chapter 2: THE
            How would you choose
             to use or allocate…
• 6 hours to study for Math, English and Econ
• Php 100 of your daily allowance?
• 5 hectares of agricultural land?
• Php 50 million of CDF if you were the Governor
  of your province?
• Php 1 trillion budget for the Filipino people?
   Scarcity of resources: Economic Problem
               Problem of Choice
    The Basic Economic Questions
    What to produce?
    How much to produce?
    How to produce?
    For whom to produce?
      The basic economic questions
(a) What to produce?
    - Do we produce everything in this country? If not, which goods will we
    produce here and which goods will we import?

(b) How much to produce?
    - Once we have decided what goods to produce, next question: How much of
    each good will we produce?

(c) How to produce?
    - Suppose we have decided on quantities of goods that will be produced. next
    question: what techniques to use in production?

(d)   For whom to produce?
      - Who benefits from the goods that were produced?
     Technological Choices and the Production
           Possibilities Frontier (PPF)
   PPF  a tool useful for illustrating choices
    available to society and its constraints
   PPF  all the possible combinations of the
    maximum amounts of two goods and
    services that can be produced with a given
    amount of resources
         Assumptions about the PPF

   Only two goods are produced: food (F) and
    clothing (C)
   The society has limited resources (in fixed
   Aside # 1: can assume that the resources are
    land, labor, and capital
   Aside # 2: capital  physical capital like
    machinery, buildings, etc.
    Example of PPF: all resources used
                                 OC or rate
                                 of trade-off

    FOOD CLOTHING F C            C
     (F)    (C) Specializing in
                  clothing prodn
A     0    1000
B    100    950          100 -50 -0.5
C    200    850          100 -100 -1
D    300    650 Speciali 100 -200 -2.0
E    400    400 -zing 100 -250 -2.5
                in food
F    500     0 prodn 100 -400 -4
                   Notes on the PPF (1)
(1)   Interpretation of points, say pt. D:
         If we use all resources, we can produce at most
          300 units of Food and 650 units of Clothing
(2)   Trade-off
         If we want to  Food prodn, must Clothing
(3)   Opportunity Cost of Food
         amount of Clothing that must be given up to
          produce an extra unit of Food
         Between points A and B, OC of F is 0.5
                   Notes on the PPF (2)
(4)   Opportunity cost
         the value of the best foregone alternative
(5)   Rate of trade-off is increasing
         in absolute value  increasing opportunity cost
          of F
(6)   Implication
         As we produce more of F, it gets harder to
          substitute F for C
            Graphical Illustration of PPF
    C           Pts on the PPF are efficient-
              fully employed resources using
1,200                 best technology
1,000           B
                                                          Unattainable or
                          C                           infeasible given current
 800                                                       resources and
            Unemployment              D                      technology
 600         of resources
                            I                     E        N
    0                                                                  F
        0    100        200        300          400      500
    Does PPF answer Basic Econ Questions?
   What to produce?
       Shown by 2 goods on axes of PPF
   How much to produce?
       Shown by points along PPF
   How to produce?
       Use technology that will enable economy to
        produce goods represented by points along PPF
   For whom to produce?
       Not shown by PPF
                 in resources and/or techno
Shifts in PPF     improvements leads to an
                  outward shift in the PPF
C                       in resources and/or techno
                         improvements in clothing
                         production only

                              in resources and/or techno
                               improvements in food
                               production only

                                     in resources and/or
                                     techno improvements
                                     of both F and C prodn

 0                                                    F
            Economic Systems &
        The Basic Economic Questions
2 extreme economic systems

  • complete command economy
 decisions made by “authorities”

  • completely unregulated market economy
      market is the institution that determines
       the answers.

* actual economies fall somewhere in between

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