What is meant by macroeconomic theory?

(i) PP curve slopes down. Why? PP curve slopes down from left to right because in presence of scarcity of resources more of one good can be produced only if resources are withdrawn from production of other good. In other words production of one good can be increased only after sacrificing some quantity of other good. For example in the marginal opportunity cost schedule given in Q. 1.12 we find in combination B that 1 lakh ton of wheat is produced by sacrificing production of 1 (= 15 - 14) thousand tanks and in combination C, the same amount of wheat is produced by sacrificing 2 (= 14 - 12) thousand tanks. In other words as production of one good (here wheat) increases that of other good (here tanks) falls. It is so because resources are fixed (limited) and production of both the goods can't be increased. As a result PP curve slopes down from left to the right as shown in Fig. 1.1 and Fig. 1.2.

(ii) Concave shape of PP curve. PP curve looks concave to the origin because of increasing marginal opportunity cost (or MRT). Increasing marginal cost implies that for producing an additional unit of a good, sacrifice of units of other good (i.e., opportunity cost) goes on increasing. MRT increases because it is assumed that no resource is equally efficient in production of all goods. So it becomes difficult to substitute resources specialised in production of one good (say tanks) to production of other good (say wheat). For instance in Production Possibility Cost Schedule given in Q. 1.12, we find for each increase of 1 lakh ton of wheat, sacrifice of tanks has been increasing successively from 1 thousand to 2 thousand; therefrom 2 to 3 thousand tanks and so on. This raises cost (marginal opportunity cost) which is technically called marginal rate of transformation (MRT). As a result of increasing MRT, shape of PP curve becomes concave to the origin.

In short PP curve becomes concave because marginal rate of transformation (marginal opportunity cost) rises as resources are diverted from production of one good to one other.

Note, (i) PP curve will be a straight line if sacrifice of units of other good is constant, i.e., if Marginal Opportunity Cost/MRT is constant, (ii) PP Curve will become convex if sacrifice of units of other good goes on decreasing.

1. Economy. 'An economy is a system by which people get their living' — A.G. Brown. People earn incomes by rendering productive services so as to get goods and services for satisfaction of their wants. Thus an economy is a system that (i) helps to produce goods and services, and (ii) enables people to earn income for buying goods and services. Hence all such institutions and organisations operating in a defined area which produce goods and services and enable people to earn incomes are collectively called an economy. It is an integrated system of economic activities concerning consumption, production, exchange and distribution of wealth.

2.    Goods. All physical and tangible things (objects) which are used to satisfy peoples' wants and have economic value (i.e., command price) are called goods., e.g. shirts, shoes, books, pens, chairs etc.

3.    Services. Services are non-material (intangible) goods, which cannot be seen, touched, stored or shifted and have power to satisfy people's wants and needs, e.g., services of manager, doctor, teacher, chowkidar etc. Services are tasks performed for someone and have economic value.

4.    Wants. Wants are mere desires to possess irrespective of price and capacity to buy the object (commodity) whereas demand is an effective desire backed by purchasing power to buy the commodity at a particular price.

5.    Resources. Goods and services which are used to produce other goods and services are called resources. These are categorised as natural resources (land), human resources (labour and entrepreneur) and manufactured resources (capital). Land, labour, capital and entrepreneur are conventionally called factors of production.

6.    Households. A household is an institutional unit (a family unit) whose main activity is consumption. Households supply factor services to firms. It is a group of persons normally living together and taking food from a common kitchen.

7.    Firms. A firm is an institutional unit which produces goods and services for the market. It is also called an enterprise owned and operated by an individual or by group of individuals.

8.    Commodities. Goods and services for sale in the market are called commodities. Mind, goods denote material goods whereas services denote non-material goods but the term commodities include both goods and services.

9.    Production. Production is an activity which produces material goods and services. Alternatively production is a process through which inputs are transformed into output (finished product). Mind, the term 'product' denotes both goods and services.

10.    Consumption. The process of using up of goods and services for direct satisfaction of individual or collective human wants is called consumption.

(a) Marginal Opportunity Cost. MOC of a particular good (say wheat) along a PP curve is the amount of the other good (say tanks) which is sacrificed to produce an additional unit of that particular good. The rate of this sacrifice is called marginal opportunity cost of the expanding good. Rate of sacrifice is technically termed as marginal rate of transformation (MRT).
MRT is the ratio of units of one good (say, tanks) that needs to be sacrificed to produce one more unit of the other good (say, wheat). Symbolically :

 A close look at the above table reveals that as production of wheat is increased, its marginal opportunity cost (MOC) in terms of tanks goes on increasing, i.e., MRT is rising. For example, when society moves from combination A to B, it sacrifices 1 (= 15 - 14) thousand tanks to produce 1 (= 1 - 0) lakh ton of wheat. Thus MOC of 1 lakh ton of wheat is 1 thousand tanks in the beginning, i.e., MRT = 1 : 1. Likewise in combinations C, D, E and F, MOC of producing 1 lakh ton of additional wheat is 2 (= 14 -12) thousand, 3(= 12 - 9) thousand, 4(= 9 - 5) thousand and 5(= 5 - 0) thousand tanks respectively. In short for every unit increase in production of wheat, more and more tanks are to be sacrificed, i.e., marginal opportunity cost, i.e., MRT goes on increasing. But why does MOC increase? Following are its two main reasons.

(b) Reasons for increasing marginal opportunity cost (or MRT)

(i) Operation of law of diminishing returns (or increasing cost). According to this law, if more and more units of a good are to be produced, the additional units will require more and more of factors units, i.e., cost of production of additional units of the good will increase.

(ii) Transferring resources from more productive to less productive uses. Various resources are specialised in production of different goods. When factors (resources) which are specialised for production of a particular good (say, workers manufacturing tanks) are transferred to the production of another good (say, production of wheat) for which they are less productive, some productivity is lost. Therefore, more of such resources (say workers) are needed to produce an additional unit of other good. This implies increase in marginal opportunity cost making the PP curve concave in shape.