Production Possibilities Frontier

A production possibilities frontier shows the various combinations of goods that an economy is capable of
producing with its existing stocks of economic resources and technology.
It slopes downward because given a fixed amount of inputs and a constant state of technology, the
production of more quantities of a particular good will always lead to the production of fewer quantities of the other
good. It may shift to the right if technology improves or the supply of factor inputs increases.
A rightward shift of the production possibility curve indicates an increase in the quantity of goods and
services that can be produced during a specific period of time.
The downward slope of the ppf reflects the trade-offs that occur as more resources are devoted to the
production of a particular good given a fixed supply of inputs or state of technology

CLOTHING FOOD
70 0
60 20
40 50
20 70
0 80

Production Possibility Curve

90
80
70
60
50
Food

40
Series 1
30
20
10
0
0 20 40 60 80
Clothing

The production possibility curve is bowed out because some inputs are better suited to producing one particular good
than they are in producing another good.

An Increase in the Production Curve

90
80
70
60
50
Food

40 Series 1
30 Series 2
20
10
0
0 10 20 30 40 50 55 60 70 80 90 100
Clothing
 An Increase in the Production of Both Goods
90
80
70
60
50
Food

40 Series 1
30 Series 2
20
10
0
0 10 20 30 40 50 55 60 70 80 90 100
Clothing

The negative slope of the production possibility curve implies that the economy must give up certain quantities of
food to produce one unit of clothing.

At point B, the opportunity cost of an extra unit of clothes =

Clothing Food O.C (clothes)

Point A 0 80
Point B 20 70 10/20 = 0.5
Point C 40 50 20/20=1
Point D 60 20 30/20 = 1.5
Point E 70 0

The Role of Prices

Price performs very important functions in the economy, the rationing, signaling, and the resource-allocation
functions.

Rationing power of price allows the distribution of limited amounts of available output among buyers who are willing
to pay for them.

Prices signal producers as to what and how much of the product or the service they must produce.

Prices motivate producers to efficiently combine and utilize the resources need in the production of the most valued
commodity in the market.

Market
A market is an interaction between buyers and sellers of trading or exchange. It is where the consumer buys
and the seller sells. The goods market is the most common type of market because it is where we buy consumers
goods. The labor market is where workers offer services and look for jobs and where employers look for workers to
hire. Financial market includes the stock market where securities of corporations are traded.

The Law of Demand

Demand is one of the most important economic concepts that every entrepreneur must understand. It is the
willingness of a consumer to buy a commodity at a given price. The market demand is the sum of all the quantities of
goods and services people will buy at a certain price level.
The demand curve is a graphical illustration of the demand schedule, with the price measured on the vertical axis (Y)
and the quantity demanded measured on the horizontal axis (X).

12

10

8
Price

4 Series 1

0
1 2 3 4 5
Quantity demanded ( in bottles)

Income effect is felt when a change in the price of a good changes consumer’s real income or purchasing power,
which is the capacity to buy with a given income.

Substitution effect is felt when a change in the price of a good changes demand due to alternative consumption of
substitute goods.

The Law of Demand

After observing and evaluating the changes of price and quantity demanded, the Law of Demand can be
stated. It is then stated that, ceteris paribus or else being equal, people tend to buy more at lower prices and less at
higher prices.

Non-Price Determinants of Demand

If ceteris paribus assumption is dropped, non-price variables that affect the demand are now allowed to
influence demand. Non-price determinants can cause an upward or downward change in the entire demand for the
product which is also referred to as a shifht of the demand curve.

The demand function: D = f(P,T,Y,E,PR,NC), which states that demand for a good is a function of Price (P), Taste (T),
Income (Y), Expectations (E), Price of Related Goods (PR) and number of Consumers (NC)

If consumer income decreases, the capacity to buy decreases and the demand will also decrease even when price
does remain the same.

Improved taste for a product will cause a consumer to buy more of that good even if the prices does not change.

Price of related goods also determines demand. Substitute goods are those that are used in place of each other.
Complements are goods that are used together.

A normal good is a good whose demand rises as income increases

An inferior good is a good whose demand falls as income rises

The Law of Supply

There is a direct relationship between the price of a good and the quantity supplies of that good. As price
increases, the quantity supplied of that product also increases. When price of the goods increases, the quantity
supplies of the good increases since the seller will take this as an opportunity to increase his/her income.
Supply shows the quantity of goods and services that seller will offer in the market at certain prices in a
period of time.
Assuming that the cost of production remains the same, seller will earn higher profits at a higher price. Producers are
motivated to sell more at a higher price. Given the supply function QS= -100 + 3P, substitute the P values in the supply
function, and solve for Qs to complete the supply schedule.

If the price is P80.00

Qs= -100 + 3(80) = 140
(-100) is the value when the price is Zero

P Qs
20 100
24 150
60 200
80 250
100 300

Supply Curve

The supply curve is upward sloping. The positive slope implies that there is a direct relationship between
price and the quantity supplies. Sellers sell more at a higher price.

Supply Curve
100

80

60
Price

40
Series 1
20

0
100 150 200 250
Quantity

Change in Quantity Supplied

An upward movement along the supply curve indicates an increase in the quantity supplies of a good or a
service. It is initiated by a corresponding increase in the price of the product. A downward movement indicates that
quantity supplied has declined due to a decrease in price.

Changes in Supply
A change in supply can be illustrated well by a shift in the location of the supply curve. An increase in all the
quantities supplied at each price level leads to a rightward shift in the supply curve.

Table 1. Supply Schedule for Product X during the Month

P Qs1 Qs2
20 100 120
24 150 170
60 200 220
80 250 260
100 300
 Figure 1. Supply Curve
100

80

60

Price
40
Series 1
20

0
100 150 200 250
Quantity

Determinants of Supply
 Subsidies and taxes (government intervention). Subsidy: a payment from the government to
producers. It lower the cost of production. Tax: Excise taxes or indirect consumption taxes increase
the cost of production
 Technology: new technology leads to more supply
 Other related goods’ prices.
 Resources costs. Land, labor and capital. Example: falling wages should increase supply of
manufactured goods since it becomes cheaper to produce goods ones the wages that the firms have
to pay have decrease
 Expectations of producers of future prices. Higher expected prices should lead to an increase in
supply
 Size of the market. Refers to the number of firms producing of goods

Market Equilibrium
The operation of the market depends upon the interaction between buyers and seller. Market equilibrium
exists when quantity supplied equals quantity demanded. Hence, there is no tendency for the market price to change
at equilibrium. Supposed the demand and supply functions of a product were described as Qd = 500 – 2P and Qs = -
100 +3P.
500 – 2P = -100 + 3P Table 2. Demand and Supply Schedule for Product X
500+100= 3P + 2P
600= 5P P Qd Qs
Pe= 120 80 340 140
100 300 200
Qe = 500 – (120) 120 260 260
= 500 – 240 140 220 320
Qe = 260 160 180 380