UNIT 6: FUNDAMENTAL PRINCIPLES OF ECONOMICS
Key unit competence: To be able to apply fundamental economic principles in daily business life
Introductory activity
Human beings hardly get satisfied in life. Those who are unemployed wish one day to be employed. The employed on their part, wish to get a promotion and a salary increase. Those with small vehicles desire to own bigger vehicles like Toyota Prado. Those owning bigger vehicles wish they could own jets. People living in rural areas want to move to urban areas, while those in urban areas want to own land in rural areas. Countries too desire to own some assets but they cannot access them.
a) Identify other scenarios showing that human beings, families or governments are never satisfied.
b) Why is this always the case?
c) Suggest any solution(s) to the above scenarios
6.1. Meaning and relationship of fundamental principles of Economics
Learning activity 6.1
Case study: Read the short conversation provided below and use it to answer the questions below:
John: Good morning my friend?
Muhire: Good morning to you.
John: You look moody today. What is the problem?
Muhire: I have FRW 40,00 only. This morning, I went to the market to buy 25 Kgs of rice, Mayonnaise, the school uniform for my son Rugwiro, and some scholastic materials for his sister Keza. Unfortunately, I found that there was a deficit of FRW 15,000
John: Ooh, sorry my friend. Resources have never been sufficient. You should prioritize your needs and buy what is fitting in your financial means. For example, you can just buy 15 kgs of rice, pay for the school uniform for Rugwiro, and buy some scholastic materials for Keza. Mayonnaise shall be bought late alone!
Muhire: John! That’s great advice.
John: Listen! On top of that, you can just buy avocados to replace U.S. Mayonnaise. Avocados are cheap, and good for human health compared to industrial Mayonnaise. That is how I deal with such situations when I have insufficient money to buy all I need.
Muhire: Now, I can see why you are always happy. Thank you so much. Now I will always make choices of what to buy at a time with scarce financial resources.
Questions:
1. Using the conversation above and the knowledge acquired in senior one (Unit 4: Concept of needs, wants, goods and services), explain the following:
a) Scarcity
b) Choice
c) Opportunity cost
2. Using your own example, discuss the relationship between scarcity, choice, and opportunity cost.
6.1.1. Meaning of fundamental principles of Economics
Learning activity 6.1
Human wants are unlimited and the resources satisfy them are limited. As a result, the fundamental principles of economics explain this concept. These principles include scarcity, choice and opportunity cost. They further show the fundamental problems of human beings in their bid to try and use the scarce resources to satisfy the unlimited wants.
a. Scarcity
This refers to the limited supply or insufficiency of resources in satisfying the needs of an individual, family, or state, in relation to the unlimited wants. Due to the problem of scarcity, one must make rational choices by satisfying the most pressing wants first and then the least pressing ones last. As a result, there is a need to prioritize by making a list of one’s wants in order of satisfying. In the list, the most pressing needs are put at the top to be satisfied first, and then the less pressing ones are put last on that list. This list is known as the scale of preference.
b. Choice
Choice refers to the act of making a right decision at the right time to use limited or scarce resources to satisfy the unlimited wants. For instance, a student who has a limited amount of money can opt to buy a textbook to use in the classroom, rather than buying sports shoes to be wearing over the weekends.
c. Opportunity cost
Opportunity cost arises out of scarcity and choice. When choice is made, it means that some wants, and needs are left unsatisfied. They are foregone. The immediate alternatives foregone when choice is made is called opportunity cost. Opportunity cost is what you miss when you make a choice.
In nutshell, scarcity leads to choice, and choice creates opportunity cost.
6.1.2. Production Possibility Frontier (PPF) curve
A production possibility frontier (PPF) is a locus of points showing the possible combinations of two commodities that can be produced when all the resources are fully utilized.
It is also called the transformation curve or the opportunity cost curve.
a. Assumptions of the PPF curve
– It assumes that only two commodities are produced
- It assumes that the level of technology is fixed and constant
– It assumes that all resources are fully utilized
– It assumes that similar resources will be used to produce both two goods.
b. Importance of the PPF
– The PPF shows whether there is economic growth or decline in the country. An outward shift indicates economic growth.
– The PPF shows the rate of unemployment by showing the rate at which resources are employed or utilized. Points along the PPF show full employment and utilization of resources Points inside PPF show the unemployment and underutilization of resources.
– The PPF shows the combination of goods and services that can be produced in an economy
– It indicates technological advancement within an economy. When the level of production increases, the PPF shifts outwards. This indicates technological advancement.
The hypothetical production possibility schedule
In the above illustration, A and F are the possibilities in which the producer can produce either 200 units of Good Y only or 100 units of Good X only with given resources. However, the assumption is that both are produced. There are therefore various combinations A, B C, E and F that can be produced.
On combination A, only good Y can be produced and nothing of X; at B, 190 units of Y and 50 units of X; At point C, 150 units of Y and 90 units of X; at E,120 units of Y and 95 units of X; while at F, 0 units of Y and 100 units of X are produced.
The PPF shows that when more units of Good X are produced, less units of Good Y are produced. This implies that the producer withdraws some resources from the production of Good Y and uses them in producing more units of Good X. This transforms resources producing Good Y into production of Good X. It is for this reason that the curve is also called a transformation curve.
Point M inside the PPF, indicates that the level of output is attainable but undesirable. This is because rationality requires that one prefers more to less. Point P outside the PPF, is not attainable using the available resources. However, it may be attained should the available resources be increased.
6.1.2. Relationship between scarcity, choice and opportunity cost
The PPF indicates what is attainable and what is not attainable given the level of resources. Due to scarcity of resources, a producer cannot produce the maximum level of output for the two goods at once. The producer makes a choice to either produce more of Good X and less of Good Y and vice- versa. If the producer produces more of Good X he foregoes units of Good Y (opportunity cost) as shown by the PPF.
a. Shifts in the PPF
The PPF may shift inwards or outwards.
A shift of the PPF inwards indicates economic decline while a shift outward indicates economic growth.
b. a shift of the PPF curve outwards and inwards Example
The table below shows a cooperative producing alternative combinations of potatoes and beans in tones per period.
The information in the table is presented graphically. We measure tonnes of beans on the Y axis and potatoes on the X axis
Let us assume all the resources are used to produce just two goods, potatoes, and beans. Various possible combinations that could be produced in each month are shown in the above table. For instance, the cooperative in the months of January-march, by using all its resources to produce, could produce 5 tones of potatoes but no beans. Alternatively, in the months of April-June by producing, say 48 tones of beans it could release enough resources to produce 4tonnes of potatoes. At the other extreme in the months of July-September it could produce 90tonnes of beans without any resources being used to produce potatoes. An outward shift from Y60, X10 to Y90, X15 indicates economic growth.
This may be due to any of the following reasons:
• Discovery of new natural resources.
• Advancement in technology that leads to production of more goods and services
• Expansion of markets that encourage production of more goods and services.
• Improvement in the skills of labour that results into efficiency in production
• Increased investment as a result of improved entrepreneurship skills
The fact that to produce more of one good involves producing less of the other is illustrated by the downward sloping nature of the curve. An inward shift from Y60 X10 to Y30 X5 indicates an economic decline.
This may be due to any of the following reasons
– Lack of new natural resources.
– Decline in the invention and use of technology that leads to production of poor quality and fewer goods and services.
– Decline in the markets which discourages production of more goods and services.
– Decline in the availability of trained manpower, through retrenchment of workers. This results into less output and inefficiency in production.
– Decreased investment because of poor entrepreneurship skills.
Application Activity 6.1
Keza Ltd produces two varieties of shoes: Sandals (Y) and Boots (X). It can produce the following quantities using the same level of resources
Questions:
a) Discuss what the firm can do to increase production of Boots (X).
b) Derive the Production Possibility Frontier (PPF) by plotting the quantities of Y on the y-axis and the quantities of X on the x axis. Later, join the points.
6.2. Fundamental economic questions
Learning activity 6.2.
Case study
Inyange Industries Ltd is a firm that deals in production of milk, ghee, juice, and bottled water. In starting the firm, proprietors made several choices concerning its location, the tools, and human resources to employ, the time to engage in production, and the kind of goods to produce. They also identified the consumers of their products.
Identify and discuss the various economic questions answered by Inyange Industries in the above case study
In allocating resources in the production of goods and services, countries and production firms face a number of fundamental economic questions.
These fundamental economic questions include:
a. What to produce?
Here the firm needs to decide on the nature of the goods to produce. The firm may decide to produce capital goods or consumer goods.
b. How to produce?
The producer must decide on the methods and techniques to be used in the production process. The producer may decide to use capital intensive techniques of production of labor-intensive techniques of production. The technique of production minimizes costs while at the same time maximizes the level of output.
c. When to produce?
The producer is required to decide whether to produce now or to produce in future. The producer is normally guided by the demand for the producer in the market. The best time for production is when the demand for the goods or services is the highest.
d. Where to produce?
The producer has to determine the location of his or her firm or industry. The location will depend on availability of the market, the source of raw materials, security and transport and communication networks. All in all, a thorough assessment of the impact of that firm to the environment must be carried out and evaluated.
e. For whom to produce?
The producer considers the target consumers that will be using the goods to be produced. The produce may be for the young, the rich, the poor, and the rural people or for the urban people.
Application Activity 6.2
Think of a possible business you intend to start after your secondary education, and answer the following economic questions:
i) What will you produce?
ii) How will you produce it/them?
iii) When will you produce it? Why?
iv) Where will you locate your business? Why?
v) Who will be your target consumers?
vi) Why is it important to ask economic questions before an entrepreneur starts a business or production?
Skills Lab 6Visit your business club, use some data extracted from the books of the business club you are a member of, to do the following:
– Explain the relationship among scarcity, choice, and opportunity cost.
– Illustrate the PPF curve for the business club.
End of Unit 6 assessment:
1. What are the fundamental economic principles?
2. Mutoni has one acre of fertile land on which she can grow tomatoes and cabbages.
She divided the land.
Questions:
i) Plot the information on the graph. Plot quantity of tomatoes on the x-axis and cabbages on the y-axis.
ii) What is the maximum quantity of cabbages that Mutoni can harvest when she uses all the land for growing cabbages?
iii) What is the maximum quantity of tomatoes that Mutoni can harvest when she uses all the land for growing tomatoes? iv) Identify any other three points on the curve and name them a, b and c
v) Estimate the output combinations of cabbages and tomatoes at the point a, b and c. 1. In not more than 200 words, discuss the major economic questions that an entrepreneur has to answer as he or she prepares to engage in production.