ANNEXURE 1.

1
Production Possibility Curve/ Frontier PPC/PPF
The Production Possibility Frontier (PPF) or Production Possibility Curve (PPC) is the graphical expression of both the concepts of limitation of resource and opportunity cost. It shows the maximum amounts of production that can be obtained by an economy. Assuming that the technological knowledge and quantity of input is fixed and the economy operates at its level of productive efficiency1). In a very simple sense, the graph that depicts opportunity cost between any two given items produced by an imaginary economy is known in economics as the PPC or PPF. A classic illustration of the concept of PPF (posed by Otto von Bismarck, Former German chancellor) envisions an imaginary economy capable of producing only two products: Guns and Butter (i.e. military goods verses civilian goods). If all the resources of this economy were used to produce guns, let's imagine that 15,000 guns could be produced (at point A). If, instead, all the resources were used to produce butter, let's imagine that 5 million pounds of butter could be produced (at point F).
1 6

Gun (thousands)

Alternative Production Possibilities Possibilities A B C D E F Butter 0 1 2 3 4 5 Gun 15 14 12 9 5 0

1 4 1 2 1 0 8 6 4 2 0 0

BA
A

CA
A

H DA
A

Outside the PPF (inability/ scarcity/ resource constrained/ impossible/unobtainable)

G
Inside the PPF (inefficient/ unemployed/under utilization points)
1 2 3

EA
A

FA
A

B utter (m illion po unds)

Figure: Shift of Production Possibility Frontier (PPF)Figure: The Production Downward shift shows Possibility Frontier (PPF) of PPFthe schedule of choices along which society can choose to substitute guns for butter

The PPF shifts inward when an economys ability to produce decreases, (reflecting a decrease in the aggregate number of military and civilian goods that can be produced). This is possible due to some major disaster, such as hurricanes or Previous PPF military invasion. The PPF of the Iraq probably shifted inward due to the US invasions. Microeconomics focuses on the behavior of decision makers in the economy. A person in his or her role as a consumer or a worker is a decision maker. Business firms and governments are decision makers too. Microeconomics centers on how New PPF these decision makers choose among alternatives and what are the results of these choices.

Productive efficiency occurs when society cannot increase the output of one goods without cutting back on another good i.e., an efficient economy is on its production- possibility frontier.

G u n (t h o u s a n d)

Butter (million pound)

Microeconomics and Macroeconomics:

Microeconomics is built around three basic types of choice that must be made in any economy: (1) What goods and services should be produced, and how much of each time period? (2) How shall they be produced, with what proportion of labour to machinery, or of machinery to natural resources, or of natural resource to labour and with in the work force, with what proportion of more skilled to less skilled workers? (3) To whom shall the final products be distributed? How much should go to the suppliers of labour, how much to the suppliers of labor, and how much to the suppliers of machinery and equipments? Or if we look at the distribution question through personal glasses, how much should go to the poor, how much to the middle classes and how much to the rich? All these problems are interrelated. Microeconomics is traditionally constructed from two branches, the theory of the firm and the theory of the consumer. The former studies the supply of goods by profitmaximizing agents, and the latter studies consumption by utility-maximizing agents. The counterpart to the supply and demand for goods by consumers is the supply and demand for labor by firms. Macroeconomics is the part economic analysis that deals with aggregate or grand total economic activity. The actions of the separate decision makers that are analyzed in macroeconomics are added together in macroeconomics in order to focus on things that affect the economy as a whole. The two main topics of macroeconomics are inflation and unemployment, although there are important macroeconomics aspects to international trade and economic growth as well. Distinction between Micro & Macro Economies Micro Economies: Macro Economics: Examines the economic behaviour of Examines an economy as a whole individual actors such as businesses, with a view to understanding the households, and individuals, with a interaction between economic view to understand decision making aggregates such as national income, in the face of scarcity and the employment and inflation. allocation consequences of these Studies the functioning of the decisions. economy as a whole. Studies the strengths & weakness of Examine how the level & growth of market mechanism. out put are determined. Observes through a microscope Analyses inflation & unemployment. Explain how individual price are set. Inquires about total money supply. Investigates why some nations thrives while others stagnate. Wide angle view of economy.

SIGNIFICANCE/ADVANTAGES OF ECONOMICS Economics as we have discussed earlier is concerned with the satisfaction of human wants. It is related to production, consumption and distribution of resources in the economy among individuals and groups. Economics, these days touches every one, whether he is an employee, a businessman, a tailor, an advocate, a laborer, a banker or a house-wife. Economics has got both theoretical and practical significance.

Theoretical Advantages 1. Increases in knowledge. The study of Economics helps us to understand the concepts of national income, employment, consumption, savings, capital formation, investment, price mechanism, demand and supply etc. It also enables us to understand the fiscal, monetary and industrial policy of the government. 2. Developing analytical attitude. Economics as a science creates and develops logical thinking towards various economic problems. The study of Economics makes us capable of analyzing various data regarding economic events. Practical advantages Economics has got the special advantage for the following sections of our society: 1. Significance for the consumers: Every consumer has limited means to satisfy his unlimited wants. Economics is significant for the consumers in the sense that it tells them, how to make the best possible use of the funds available with them among different heads. 2. Significance for producers: Production is the effective combination of land, labour, capital and enterprise as factors of production. Producers attain the knowledge of producing maximum quantity of goods at minimum cost. Economics helps the producers in determining the remuneration of various factors of production, i.e.,

wages to workers, rent to land, interest to capital and profit to entrepreneur. It also helps the producers in the fixation of the price of their commodity. 3. Significance for workers: The study of Economics enables workers to understand their significance in the production process. They are also in a position to understand the concept of wages. They discuss labour problems with the management, and save themselves from being exploited. 4. Significance for politicians: A good politician must have the knowledge of various economic problems, such as unemployment, rising prices, vicious circle of poverty and economic development of various sectors and regions. It is a tragedy that our politicians misuse the statistics to prove their point of view and not present the real situations. 5. Significance for academicians: Economics as a science develops scientific outlook. Economic theories explain the concept of consumption, production, investment and distribution. They also tell about the various economic problems, their causes, effects and their possible solutions. 6. Significance for administrators: Fiscal and monetary policies are formulated by the administrators, so they must know the theories of taxation and finance. It will enable them to understand the sources of public revenue and debt. 7. Effective man-power planning: Developing economies suffer from over-population and under-utilization of resources. Unemployment is their chronic disease. Economics will help in making effective plans for making the best possible use of all the adult people. 8. Helpful in fixing price: Economic theories regarding value and equilibrium tell the producers to raise their output upto a limit, where marginal cost equals marginal revenue. It also helps the manufacturers to fix up price under different situations. 9. Solving distribution problems. Production as we know is the result of the combination of factors of production, such as land, labour, capital and enterprise. Land is paid rent, labour is paid wages and salaries, interest is paid on capital and the enterprise gets profit. It is very difficult to fix the reasonable remuneration payable to each factor of production. Theory of distribution in Economics suggests that every factor should be paid according to its marginal productivity. Economics these days touches each and every aspects of human life.

ECONOMIC THEORY Economics, as we know is the study of economic behaviors of human-beings, so economic theories are the statements of economic tendencies of the people. While crafting economic theory the economist formulates assumption about the economic tendency, he observes the tendency, analyses the fact and reaches the conclusion. In this way, economic theory is a proved economic fact or an observed economic truth. Method of Economic Theory. The following two methods are used for constructing theory :

1. Deductive Method 2. Inductive Method 1. Deductive Method (Method of logical reasoning) It is a method, which goes from general to particular on the basis of general truth. We try to find out particular truth by logical discussions. In the words of Wilson Gee By deductive method is meant the reasoning from general to particular or from universal to individual. We accept certain general facts and use them in certain specific cases to prove our own accepted truth. For example, it is a universal truth that man is mortal, so Sumon, Mohan, John, Sufia and Akhtar, who are also men must die. In the same way, it is an established fact that Man is rational so he will try to purchase lesser quantity of a particular commodity when it is costlier. Masood, who is also a man, will behave in the same way and purchase lesser quantity of goods. This method assumes that the behavior of the general public will also be the behavior of individual person. Deductive method is used to put up theory regarding the economy. Studies of national income, employment, price level and international trade is made on the basis of deductive method. Most of the macroeconomic theories are based upon deductive method. It is also known as scientific method. 2. Inductive Method It moves from particular to general on the basis of our experience. According to Wilson Gee, Inductive method is the process of reasoning from particular to general or from individual to universal. We study the behaviors of an individual and reach certain conclusion. We study the behaviors of other individuals also. If we reach the same conclusion, we generalize the statement as an observed truth and the theory is shaped. For example, if we find that Rahim purchases more garments when its price falls. We observed that Sayma does the same thing. proshad and Nazrul also behave in the same way. Finally, we can generalize their behavior and an economic theory that customers have tendency to buy more of a commodity when its price falls is formed. Economic laws of consumers behavior, such as laws of diminishing utility, consumers surplus and equi-marginal utility have been developed on the basis of inductive method. Theories of rent, wages and interest are also based upon inductive method. This method is also known as Historical method, Concrete method, Analytical method and Realistic method. This is due to the fact that this method starts investigation of particular facts, historical events, and tries to generalize the findings of the observation for the whole economy. Most of the microeconomic theories are formulated according to inductive method.

The following steps are involved in the formulation of economic theory: 1. Definitions of terms and assumptions about economic behavior: The first step in the formulation of theory is to define the terms used in the theory. These terms should be specifically identified and defined in clear words, in order to avoid any confusion and misunderstanding. We are also required to lay down conditions (known as assumptions) about behavior of different units involved in the economic analysis just as households and firms. An economic hypothesis (Probable explanation of economic phenomenon) is also assumed for the construction of the theory. 2. Process of logical reasoning (deductions) : The second step is to draw conclusions regarding economic phenomenon on the basis of assumptions made. For example, increase in demand of normal goods in case of fall in price and decrease in demand in case of rise in price is an assumption. We make logical analysis and reasoning while making hypothesis. 3. Prediction and implication of theory: Conclusions drawn are called predictions and assumptions. Economic predictions are conditional statements, because they hold good if certain assumptions are satisfied. This is why, every economic law carries the words, other things remaining the same or being equal. 4. Testing of the theory: The economist is further required to test his conclusion and predictions. He will have empirical observation and testing of his conclusion in the same situations. This painstaking exercise is a must before the theory could be

generalized. If the testing reveals that the behavior in all the tests is the same, the conclusions are accepted as economic theory. In the above example, we can generalize the observed truth that the price tends to fall with the increase in the supply of the normal commodities, if other things remain the same. Conclusion In case our empirical observation goes contrary to our conclusion the assumption is rejected in favour of a valid theory or modified in the light of actual facts.
So, should this economy's resources be used in practice to produce 3 million pounds of butter (at point D), there will be an opportunity cost in terms of guns. Instead of the 15,000 guns the economy could have produced, it may now only be able to produce 9,000. Conversely, should this economy's resources be used in practice to produce 9,000 guns, there will be an opportunity cost in terms of butter. Instead of the 5 million pounds of butter the economy could have produced, it may now only be able to produce 3 million pounds. This choice can also change. But any move (upward or to the right) along the PPF involves an opportunity cost. Any increase in gun production (a move upward, like, from point D to C) would reduce the amount of butter that can be produced, while increase in civilian production (moving to the right, like, from point D to E) would reduce the economy's ability to produce military products. The exact combination of guns and butter produced depends on the mechanisms used to decide the allocation of resources (i.e., some combination of markets, government, tradition, and community democracy). However, in the imaginary economy discussed above which produces only guns and butter, the economy will be operating on the PPF (at point A,B,C,D,E) if all resources (inputs) are fully utilized and used most appropriately (efficiently). If all the resources are not utilized appropriately, then the economy will be operating somewhere inside the PPF (at point like G). Such cases of operating inside the PPF affirms economic inefficiency in using resource(s) for that certain period of time and production of an item can be increase without making trade-off against other item. In any economy, operation outside the PPF (at point like H) is not possible because of resource constrain that is known as scarcity (So, scarcity means that an economy cannot go above or the right of the PPF). The Production Possibility Curve describing this frontier is not straight, but is curved outward away from the axes to reflect the higher marginal costs that become inevitable due to diminishing returns at the extremes. In the real world, the point on the graph that describes the two given items' position will always lie somewhere well within the frontier (as at point like C,D or E ), due to the resources used by all the other goods and services that the given economy produces. Over time, the position of the PPF is not static. It shifts outward (upward and/or to the right, when an economys ability to produce increases (, i.e., an increase in the aggregate number of guns and butter that can be produced). This can happen if the availability of resources (factors of production) increases, or if technology or management skills are improved.

Upward shift of PPF

G u n (t h o u s a n d)

New PPF

Previous PPF

Butter (million pound)