FOUNDATION ECONOMICS

TOPIC 1: FUNTAMENTAL ECONOMIC

CONCEPTS & PRODUCTION
POSSIBILITY CURVE

OUT LINE
Fundamental Economic Concepts
Production possibility frontiers
Returns in Productions
Movements of Production Possibility Curve
Diminishing returns in production
Increasing Returns in Production
Constant Returns in Production
Laws of Returns
Economic Efficiency
Summary

FUNDAMENTAL ECONOMIC
CONCEPTS

What is Economics? Economic is the study of

how individuals and firms make choices in the
face of scarce resources.

Thisleadstofourfundamentalquestions,
addressing the problem of scarcity.
1. What to produce?
2. How much to produce?
3. How to produce?
4. For whom to produce?
In making a decision, there is always a trade-off
which we call it opportunity cost.

A countrys annual production

of consumption goods ( food,
clothing, furniture, etc

PRODUCTION POSSIBILITY
FRONTIER ( PP Curve)
W
A

Unattainable
Attainable

Combinatio
n
C

Combination
X

A countrys annual
production of capital
Goods ( Gold Mines,
Oil Fields)

Shows alternative

combination of two
goods that a country
can produce in a given
year by using resources
fully and efficiently
Point W. unattainable
combination
Point X- Production is
inefficient under
utilisation of resources

PRODUCTION POSSIBILITY
FRONTIER

The Opportunity Cost of moving from A to B and

B to A can be found in the following ratio

Opporunity Cost Po int A to B

Opporunity Cost Po int B to A

Y
M

.D

A
B

.C
0

loss MN

gain TZ

loss TZ

gain MN

PRODUCTION POSSIBILITY
x

Increase in the
Production X and Y.
Production
possibilities curve
shifts outward

Increase in the
production of Y only X
remains Constant.
Production
possibilities curve
rotates outward in
favor of product Y

PRODUCTION POSSIBILITY
CURVE (PP)

1)
2)
3)
4)
5)
6)
7)

The PP curve moves to a higher level

when one or more of the following
changes takes place in the Economy
Discovery of new resources of wealth
Increase in supply of labour
Improvements in productivity , skills, etc.
Technological improvement
Increase in stock of capital
Increase in the stock of entrepreneurial,
managerial, scientific and other abilities
Inventions and innovations

DIMINISHING RETURNS IN
PRODUCTION
Y

As each additional unit of factor inputs is added to the

production of ONE good say X, they become more less
productive. This is due to the imperfect factor
substitutability ( i.e. factors used in production is becoming
less suitable in the production of X than Y. The cost of giving up
the number of goods Y to obtain 1 unit of good X increases.
There is increasing cost in production.

INCREASING RETURNS IN
PRODUCTION
Y

As each additional unit of inputs is added to the production of a

good X, they become more productive. This is due to
imperfect factor substitutability (i.e. factor used in production is
becoming more suitable in the production of good X than good Y.
The number of good Y one can give up to obtain 1 unit of good X
decreases. That is why there is decreasing cost.

CONSTANT RETURNS IN
PRODUCTIONS
Y

As each additional unit of inputs is added to the production

of a good, they become productive. This is due to the
perfect factor substitutability (i.e. factor used in
production is becoming adequately suitable in the
production of good X as good Y. The number of good Y one
can give up to obtain 1 unit of good X is same. That is
why there is constant cost.

LAWS OF RETURNS
Inputs
(Units)

Total
Returns
(units of
output)

Marginal
Returns
(units of
output)

Average
Returns
(units of
output)

Types of
Returns

1
2
3
4
5
6
7
8
9

10
24
45
80
100
120
126
128
128

14
21
35
20
20
6
2
0

10
12
15
20
20
20
18
16
14.2

Increasing
Returns

Constant
Returns

Diminishin
g
Returns

ECONOMIC EFFICIENCY
The test of economic efficiency is the
reduction of average cost of production
Economic theory have traditionally argued
that this is possible in a perfect competition
The different forms of market Monopoly,
duopoly or oligopoly destroys perfect
competition
They pay no attention to production and
Economic efficiency.
These structures do no help Economy to fully
utilize all its available resources.

SUMMARY
Economics is defined to be a study of mankind
in the ordinary business of Life.
The Core Economic Problem is allocating
scarce resources.
Every Choice involves some degree of
sacrifice, and Economist call this a tradeoff or
an opportunity cost
In a circular flow of income, there are four
different economic sectors which interact with
one another: the house hold, business,
government, and foreign trade

REFERENCE
Foundation Economics: Chapter
1&2
by H.G Mannur