Some Basic Concepts
| Production Possibility curve |
| Utility (Types of utility) |
| Money |
Production possibility curve
In economics, a production–possibility frontier (PPF), sometimes called a production–possibility curve, production-possibility boundary or product transformation curve, is a graph that shows the various combinations of amounts of two commodities that could be produced using the same fixed total amount of each of the factors of production. Graphically bounding the production set for fixed input quantities, the PPF curve shows the maximum possible production level of one commodity for any given production level of the other, given the existing state of technology. By doing so, it defines productive efficiency in the context of that production set: a point on the frontier indicates efficient use of the available inputs, while a point beneath the curve indicates inefficiency. A period of time is specified as well as the production technologies and amounts of inputs available. The commodities compared can either be goods or services.
PPFs are normally drawn as bulging upwards ("concave") from the origin but can also be represented as bulging downward or linear (straight), depending on a number of factors. A PPF can be used to illustrate a number of economic concepts, such as scarcity of resources (i.e., the fundamental economic problem all societies face), opportunity cost (or marginal rate of transformation), productive efficiency, allocative efficiency, and economies of scale. In addition, an outward shift of the PPF results from growth of the availability of inputs such as physical capital or labour, or technological progress in our knowledge of how to transform inputs into outputs. Such a shift allows economic growth of an economy already operating at its full productivity (on the PPF), which means that more of both outputs can be produced during the specified period of time without sacrificing the output of either good. Conversely, the PPF will shift inward if the labor force shrinks, the supply of raw materials is depleted, or a natural disaster decreases the stock of physical capital. However, most economic contractions reflect not that less can be produced, but that the economy has started operating below the frontier—typically both labor and physical capital are underemployed. The combination represented by the point on the PPF where an economy operates shows the priorities or choices of the economy, such as the choice of producing more capital goods and fewer consumer goods or vice versa
Utility
The goods satisfy human wants. This want satisfying quality in a good is called Utility. Utility is that quality in a commodity by virtue of which it is capable of satisfying a human want. Air, water (free goods) and food, cloth etc. (economic goods) satisfies people’s wants and hence they possess utility.
In day to day life we use this term in different way but in Economics utility is having a specific meaning. Hence
a) Utility and usefulness are different. For example a poison when we consume it is definitely injurious and hence it never is useful but it satisfies the human want, i.e. the want of person who decides to suicide and hence it possesses utility.
b) Utility is not synonymous with pleasure. A good which possess utility may not give pleasure when. Consumed e.g. a medicine when a patient consumes does not give pleasure since mostly it is bitter. But it possesses utility because it is required to cure from sickness. Thus pleasure is different and utility is different.
c) Utility is subjective means no commodity possesses utility in itself independently of the consumer. It is a consumer’s mind which gives it utility. A literate person may find utility in books, new paper etc. as he is able to read those, but on the contrary an illiterate person never find any utility. Thus utility depends on mans mind rather than on the things itself.
d) Utility varies in different situations. Moreover the same things may possess different utilities for different purposes. For example water has different utilities when it is used for drinking, bathing and washing purposes.
Types of Utility:
1. From Utility: Due to change in form there is change in utility, e.g. Wood when transformed into furniture, utility will increase.
2. Place utility: When goods transported from one place to another place utility can increase. For example apple will fetch more prices in other part of country than in Kashmir and Himachal Pradesh.
3. Time utility: By storing a commodity and selling it at a time of scarcity, utility can be realized more.
4. Service utility ; When personal services are rendered directly to consumers by professionals like doctors, lawyers etc. It is said to create service utility.
5. Possession Utility: Additional consumer value created by allowing easy transferring of a product's ownership. For example, various time payment, leasing, and credit purchase strategies can be important in making a product more attractive to a consumer.
6. Knowledge Utility: when utility is derived after getting knowledge about the commodity.
- Total Utility:
It refers to the sum of all utilities obtained by a consumer from the consumption of all units of a commodity at a given time.
- Marginal:
It refers to the additional benefit derived by a consumer from the consumption of an additional unit of a commodity at a given time. - Average:
Average utility refers to utility per head. It is the utility derived per head from the consumption of a given stock of a commodity. It is the ratio of total utility to the number of units consumed. It is denoted by AU = TU/N
Money
Money is a good that acts as a medium of exchange in transactions. Classically it is said that money acts as a unit of account, a store of value, and a medium of exchange. So money is what money does.
Various functions of money can be classified into three broad groups:
(a) Primary functions, which include the medium of exchange and the measure of value;
(b) Secondary junctions which include standard of deferred payments, store of value and transfer of value; and
(c) Contingent functions which include distribution of national income, maximization of satisfaction, basis of credit system, etc. These functions have been explained below:
1. Medium of Exchange:
The most important function of money is to serve as a medium of exchange or as a means of payment. To be a successful medium of exchange, money must be commonly accepted by people in exchange for goods and services. While functioning as a medium of exchange, money benefits the society in a number of ways:
(a) It overcomes the inconvenience of baiter system (i.e., the need for double coincidence of wants) by splitting the act of barter into two acts of exchange, i.e., sales and purchases through money.
(b) It promotes transactional efficiency in exchange by facilitating the multiple exchange of goods and services with minimum effort and time,
(c) It promotes allocation efficiency by facilitating specialization in production and trade,
(d) It allows freedom of choice in the sense that a person can use his money to buy the things he wants most, from the people who offer the best bargain and at a time he considers the most advantageous.
2. Measure of Value:
Money serves as a common measure of value in terms of which the value of all goods and services is measured and expressed. By acting as a common denominator or numeraire, money has provided a language of economic communication. It has made transactions easy and simplified the problem of measuring and comparing the prices of goods and services in the market. Prices are but values expressed in terms of money.
Money also acts as a unit of account. As a unit of account, it helps in developing an efficient accounting system because the values of a variety of goods and services which are physically measured in different units (e.g, quintals, metres, litres, etc.) can be added up. This makes possible the comparisons of various kinds, both over time and across regions. It provides a basis for keeping accounts, estimating national income, cost of a project, sale proceeds, profit and loss of a firm, etc.
To be satisfactory measure of value, the monetary units must be invariable. In other words, it must maintain a stable value. A fluctuating monetary unit creates a number of socio-economic problems. Normally, the value of money, i.e., its purchasing power, does not remain constant; it rises during periods of falling prices and falls during periods of rising prices.
3. Standard of Deferred Payments:
When money is generally accepted as a medium of exchange and a unit of value, it naturally becomes the unit in terms of which deferred or future payments are stated.
Thus, money not only helps current transactions though functions as a medium of exchange, but facilitates credit transaction (i.e., exchanging present goods on credit) through its function as a standard of deferred payments. But, to become a satisfactory standard of deferred payments, money must maintain a constant value through time ; if its value increases through time (i.e., during the period of falling price level), it will benefit the creditors at the cost of debtors; if its value falls (i.e., during the period of rising price level), it will benefit the debtors at the cost of creditors.
4. Store of Value:
Money, being a unit of value and a generally acceptable means of payment, provides a liquid store of value because it is so easy to spend and so easy to store. By acting as a store of value, money provides security to the individuals to meet unpredictable emergencies and to pay debts that are fixed in terms of money. It also provides assurance that attractive future buying opportunities can be exploited.
Money as a liquid store of value facilitates its possessor to purchase any other asset at any time. It was Keynes who first fully realised the liquid store value of money function and regarded money as a link between the present and the future. This, however, does not mean that money is the most satisfactory liquid store of value. To become a satisfactory store of value, money must have a stable value.
5. Transfer of Value:
Money also functions as a means of transferring value. Through money, value can be easily and quickly transferred from one place to another because money is acceptable everywhere and to all. For example, it is much easier to transfer one lakh rupees through bank draft from person A in Amritsar to person B in Bombay than remitting the same value in commodity terms, say wheat.
6. Distribution of National Income:
Money facilitates the division of national income between people. Total output of the country is jointly produced by a number of people as workers, land owners, capitalists, and entrepreneurs, and, in turn, will have to be distributed among them. Money helps in the distribution of national product through the system of wage, rent, interest and profit.
7. Maximization of Satisfaction:
Money helps consumers and producers to maximize their benefits. A consumer maximizes his satisfaction by equating the prices of each commodity (expressed in terms of money) with its marginal utility. Similarly, a producer maximizes his profit by equating the marginal productivity of a factor unit to its price.
8. Basis of Credit System:
Credit plays an important role in the modern economic system and money constitutes the basis of credit. People deposit their money (saving) in the banks and on the basis of these deposits, the banks create credit.
9. Liquidity to Wealth:
Money imparts liquidity to various forms of wealth. When a person holds wealth in the form of money, he makes it liquid. In fact, all forms of wealth (e.g., land, machinery, stocks, stores, etc.) can be converted into money.