Q.(a) Explain basic problems of the economy with the help of production possibility curve.

(a) Scarcity forces every economy to answer three central problems — what, how and for whom to produce — which the PPC illustrates through choice and opportunity cost. (b) The Law of Demand describes the inverse relation between price and quantity demanded, subject to a few well-known exceptions.

(a) Central problems of the economy and the PPC

Because resources are scarce and have alternative uses, every economy faces three basic (central) problems:

1. What to produce and in what quantities — which goods, and how much of each.
2. How to produce — which technique/combination of factors (labour-intensive or capital-intensive).
3. For whom to produce — how the output is to be distributed among people.

The Production Possibility Curve (PPC) shows the maximum combinations of two goods (say, consumer goods and capital goods) an economy can produce when its resources and technology are fully and efficiently used. It is downward sloping and concave (bowed out) to the origin because of increasing opportunity cost.

The PPC illustrates the central problems:

• What to produce — choosing a particular point (combination) on the curve.
• How to produce — a point on the curve means resources are used efficiently; a point inside means under-utilisation, and a point outside is unattainable with current resources.
• For whom — the chosen combination decides which goods (and hence which groups) are served.
• Opportunity cost is shown by the slope: to get more of one good, some of the other must be given up. Economic growth is shown by an outward shift of the PPC.

(b) Law of Demand and its exceptions

The Law of Demand states that, other things remaining constant, there is an inverse relationship between the price of a good and its quantity demanded — when price falls, quantity demanded rises, and when price rises, quantity demanded falls. Hence the demand curve slopes downward from left to right.

Assumptions: incomes, tastes, prices of related goods and expectations remain unchanged (ceteris paribus). Reasons for the law: the law of diminishing marginal utility, the income effect, the substitution effect, entry of new buyers and multiple uses of a commodity.

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