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Lecture 2

Lecture 2. PPF. Production Possibility Frontier: It shows the maximum amount of goods and services that can be efficiently produced in an economy by available inputs/resources and technology.

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Lecture 2

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  1. Lecture 2

  2. PPF Production Possibility Frontier: It shows the maximum amount of goods and services that can be efficiently produced in an economy by available inputs/resources and technology. All the points on the PPF are efficient. ( Here efficient means no more output can be produce from the given inputs/resources. That means there is no wastage of resources) All the points inside the PPF are inefficient. All the points outside the PPF are infeasible / impossible

  3. Shift of PPF Two factors can affect the PPF • Increase or Decrease in Resource/ input • Technological Change

  4. Opportunity Cost • Definition – the cost expressed in terms of the next best alternative sacrificed • Helps us view the true cost of decision making • Implies valuing different choices

  5. Production Possibility Frontiers If the economy reallocates its resources (moving round the PPF from A to B) it can produce more consumer goods but only at the expense of fewer capital goods. The opportunity cost of producing an extra X1 – Xo consumer goods is Yo – Y1 capital goods. Capital Goods Ym A Yo B Y1 Consumer Goods Xo X1 Xm

  6. Demand Curve Demand Curve: It shows how price and quantity demanded are related. Generally when the price of a product increases the demand of that product decreases and vice versa. This implies that price of a product and its quantity demanded are negatively related. So demand curve is downward sloping. Why does demand curve slopes downward? For the initial units of a good an individual gets higher satisfaction from consuming that good. So he is willing to pay more initially. But as he consumes more of a good his satisfaction from consuming the good decreases and so he will be willing to pay less.

  7. Example • Suppose we are considering a consumer who is very thirsty and wants to consume water. He will be willing to pay different prices for different units of glass of water. Initially he is very thirsty and so he will be willing to pay more. But as he drinks more water he is satisfying his thirst. So he will be willing to pay less for additional units of water.

  8. Supply Curve • It shows the relationship between price and quantity supplied. • There is a positive relation between price and quantity supplied. That means if price increases then there will be an increase in quantity supplied. • Why does it slope upward? • Moreover, higher prices embody greater incentives for firms to produce more output because profit opportunities are enhanced.

  9. Example • Suppose a supplier wants to supply water in the market. If the price is low he will supply less. He will increase his supply of water if the price of water increases.

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