Class 12: Introductory Micro-economics Chapter 1: Introduction

Question 1. Discuss the central problems of an economy.

Every economy has limited resources but unlimited human wants. Because of this problem of scarcity, every economy has to make choices regarding the use of its resources. These choices are known as the central problems of an economy.

Central Problems of an Economy

1. What to Produce and in What Quantities?

An economy must decide which goods and services should be produced and how much of each should be produced. Since resources are limited, producing more of one good means producing less of another.

Example: A country may have to decide whether to produce more food grains or more luxury cars.

2. How to Produce?

An economy must decide which technique of production should be used. The choice is generally between:

• Labour-intensive technique – Uses more labour and less capital.
• Capital-intensive technique – Uses more machines and less labour.

The technique that makes the best use of available resources and minimizes the cost of production is generally preferred.

Example: A garment factory may choose manual stitching (labour-intensive) or automated sewing machines (capital-intensive).

3. For Whom to Produce?

An economy must decide how the produced goods and services will be distributed among different people. This depends on the distribution of income and purchasing power.

People with higher incomes can buy more goods and services, while people with lower incomes can buy fewer goods.

Example: Luxury apartments are generally purchased by high-income groups, whereas affordable housing is meant for middle- and low-income groups.

Why Do These Problems Arise?

• Resources are scarce.
• Human wants are unlimited.
• Resources have alternative uses.
• Society must make choices to achieve maximum satisfaction.

CBSE Important Points

• The central problems arise because of scarcity of resources and unlimited wants.
• Every economy must answer three basic questions:
  • What to produce?
  • How to produce?
  • For whom to produce?
• These problems exist in every economy—capitalist, socialist, and mixed.
• Alternative uses of resources make economic choice necessary.

Summary Table

Question 2. What do you mean by the production possibilities of an economy?

Production possibilities of an economy refer to the different combinations of two goods or groups of goods that an economy can produce by fully and efficiently utilizing its available resources and technology during a given period of time.

Since resources are limited and have alternative uses, an economy cannot produce unlimited quantities of all goods. It must choose one of the many possible combinations of output.

Features of Production Possibilities

• Resources are scarce and have alternative uses.
• Resources are fully and efficiently utilized.
• Technology remains constant.
• Different combinations of two goods can be produced.
• Producing more of one good requires sacrificing some quantity of the other good.

Example

Suppose an economy can produce only wheat and cloth. With its available resources and technology, it can produce different combinations such as:

Each combination represents a possible level of production that the economy can achieve by using its resources efficiently.

CBSE Important Points

• Production possibilities show the various combinations of two goods that can be produced.
• They assume full and efficient utilisation of resources.
• Technology is assumed to remain constant.
• Resources are limited and have alternative uses.
• Choosing one combination involves sacrificing another, giving rise to opportunity cost.

Summary Table

Question 3. What is a Production Possibility Frontier (PPF)?

A Production Possibility Frontier (PPF), also known as the Production Possibility Curve (PPC), is a graphical representation showing the maximum possible combinations of two goods that an economy can produce by fully and efficiently utilizing its available resources and technology.

The PPF illustrates the concepts of scarcity, choice, efficiency, and opportunity cost. Every point on the PPF represents an efficient level of production.

Features of Production Possibility Frontier (PPF)

• Shows the maximum possible output combinations of two goods.
• Assumes full and efficient utilisation of resources.
• Technology remains constant.
• Resources are fixed and have alternative uses.
• Every point on the PPF indicates efficient production.
• Points inside the PPF indicate underutilisation of resources.
• Points outside the PPF are unattainable with the existing resources and technology.

Importance of PPF

• Explains the problem of scarcity.
• Shows the need for economic choice.
• Illustrates opportunity cost.
• Helps understand efficient allocation of resources.
• Shows the maximum production capacity of an economy.

CBSE Important Points

• PPF stands for Production Possibility Frontier.
• It is also called the Production Possibility Curve (PPC).
• Points on the curve represent efficient use of resources.
• Points inside the curve represent inefficient use of resources.
• Points outside the curve cannot be achieved with the available resources and technology.
• PPF is based on the assumptions of fixed resources and constant technology.

Summary Table

Question 5. Distinguish between a centrally planned economy and a market economy.

A centrally planned economy is an economic system in which all major economic decisions are taken by the government or a central planning authority. A market economy is an economic system in which economic decisions are taken by individuals and firms through the price mechanism.

Question 6. What do you understand by positive economic analysis?

Positive economic analysis is the branch of economics that studies economic facts, causes, and relationships as they actually exist. It deals with "what is" rather than "what ought to be". Its conclusions are based on objective observation, logical reasoning, and factual evidence.

Positive economics does not make value judgments or suggest what is right or wrong. It simply explains and predicts economic phenomena.

Features of Positive Economic Analysis

• Based on facts and actual economic conditions.
• Deals with objective analysis.
• Free from value judgments.
• Explains cause-and-effect relationships.
• Its statements can be tested and verified.

Examples

• An increase in the price of a commodity generally reduces its demand.
• A rise in income increases the demand for normal goods.
• Higher taxes may reduce consumers' purchasing power.

Question 7. What do you understand by normative economic analysis?

Normative economic analysis is the branch of economics that deals with "what ought to be". It is based on value judgments, opinions, and ethical considerations. It suggests policies and recommends what should be done to improve economic welfare.

Unlike positive economics, normative economics is subjective and cannot always be tested or verified because it reflects personal or social values.

Features of Normative Economic Analysis

• Based on value judgments and opinions.
• Deals with what ought to be.
• Suggests economic policies and solutions.
• Concerned with social welfare and economic justice.
• Its statements cannot be scientifically verified.

Examples

• The government should reduce income inequality.
• Taxes on essential goods should be lowered.
• Minimum wages should be increased to improve workers' living standards.

Question 8. Distinguish between Microeconomics and Macroeconomics.