Causes and consequences of shifts of a PPC in terms of an economy's growth

Cambridge IGCSE Economics 0455 – Complete Quick‑Reference Guide

1. The Basic Economic Problem

1.1 Scarcity and Choice

• Resources (land, labour, capital, entrepreneurship) are limited.
• Unlimited wants → societies must decide what, how and for whom to produce.

1.2 Factors of Production

1.3 Changes in Quantity vs. Quality

• Quantity change: More workers, more land, more machines → ↑ potential output.
• Quality change: Better education, training, more skilled workers, improved technology → ↑ productivity per unit of resource.

1.4 Opportunity Cost

The value of the next best alternative that must be given up when a choice is made. It is illustrated by the slope of the Production Possibility Curve (PPC).

2. The Production Possibility Curve (PPC)

2.1 Definition & Assumptions (Syllabus wording)

• Shows the maximum possible output combinations of two goods when all resources are fully and efficiently employed.
• Assumptions:

  • Resources are scarce and fixed in the short‑run.
  • Full employment – no unemployment or idle factories.
  • Resources are used efficiently (no waste).
  • Technology and state of knowledge are constant.
  • Only two goods are represented for simplicity.

2.2 Sketching a PPC – Checklist

1. Label the horizontal axis (e.g., Cars) and vertical axis (e.g., Food).
2. Mark the intercepts – the maximum output of each good if all resources were devoted to it.
3. Draw a bowed‑outward curve joining the intercepts (increasing opportunity cost).
4. Label the curve “PPC”.
5. Indicate possible shifts with double‑headed arrows:
   • Outward = economic growth
   • Inward = contraction

6. Mark three points:

   • A – on the curve (efficient production).
   • B – inside the curve (inefficient/under‑utilisation).
   • C – outside the curve (unattainable with current resources/technology).

2.3 Interpretation of Points & Movements

• Point A (on PPC): All resources employed efficiently.
• Point B (inside PPC): Some resources idle (e.g., unemployment, idle factories).
• Point C (outside PPC): Unattainable with existing resources/technology.
• Movement along the curve: Re‑allocation of resources; the slope shows the opportunity cost of the good on the horizontal axis in terms of the good on the vertical axis.

2.4 Causes of Shifts in the PPC (Syllabus language)

2.5 Consequences of an Outward Shift (Economic Growth)

• Higher potential output – more of both goods can be produced; standards of living rise.
• Reduced unemployment – idle resources are drawn into production.
• Possible downward pressure on prices – greater supply can ease inflationary pressures.
• Greater consumer choice – more varieties of goods and services.
• Evaluation (AO3):

  • Growth may be uneven – benefits may concentrate in the sector receiving the boost.
  • Environmental pressures can arise if growth is resource‑intensive.
  • Short‑run vs long‑run effects: initial boost may cause “boom‑bust” cycles.

2.6 Consequences of an Inward Shift (Economic Contraction)

• Lower potential output – fewer goods can be produced; living standards fall.
• Higher unemployment – resources become idle.
• Potential upward pressure on prices – if demand stays steady while supply falls.
• Reduced consumer choice – fewer goods/services available.
• Evaluation (AO3):

  • Contraction may be temporary (e.g., after a natural disaster) or structural (loss of a key export).
  • Policy responses (fiscal/monetary) can mitigate the impact.

2.7 Diagrammatic Requirements for the Exam (AO1‑AO3)

• Draw a labelled PPC with intercepts.
• Mark points A (on curve), B (inside) and C (outside).
• Show an outward shift and an inward shift with double‑headed arrows.
• Label each shift (“outward = economic growth”, “inward = contraction”).
• Briefly annotate the diagram with a note on opportunity cost (e.g., “bowed‑outward because of increasing opportunity cost”).

3. Allocation of Resources (Demand, Supply & Market Failure)

3.1 Demand and Supply Curves

• Demand: quantity of a good consumers are willing & able to buy at each price (downward sloping).
• Supply: quantity producers are willing & able to sell at each price (upward sloping).
• Equilibrium: where demand = supply; determines market price and quantity.

3.2 Price Elasticities

3.3 Market Failure & Government Intervention

• Market failure occurs when the free market does not allocate resources efficiently.

  • Public goods (e.g., street lighting) – non‑rival & non‑excludable.
  • Externalities – costs or benefits not reflected in market price (pollution, education).
  • Information asymmetry – one party has more or better information.

• Government tools:

  • Price controls – ceilings (max price) & floors (min price).
  • Taxes – reduce negative externalities (e.g., carbon tax).
  • Subsidies – encourage positive externalities (e.g., R&D grants).
  • Regulation – standards, licences, bans.

4. Microeconomic Decision‑Makers

4.1 Households

• Goal: maximise utility (satisfaction) subject to income and prices.
• Choices: consumption, saving, labour supply (work vs leisure).

4.2 Firms

• Goal: maximise profit = total revenue – total cost.
• Short‑run costs: Fixed Cost (FC), Variable Cost (VC), Total Cost (TC = FC + VC).
• Average & marginal concepts:

  • Average Cost (AC) = TC / Q.
  • Marginal Cost (MC) = ΔTC / ΔQ.

• Revenue: Total Revenue (TR) = P × Q; Average Revenue (AR) = TR / Q = P; Marginal Revenue (MR) = ΔTR / ΔQ.

4.3 Market Structures

4.4 Money & Banking (Brief)

• Money: medium of exchange, store of value, unit of account.
• Functions of a bank: accept deposits, provide loans, facilitate payments.
• Central bank (e.g., Bank of England) controls money supply and interest rates.

5. Government and the Macro‑Economy

5.1 Macro‑Economic Aims

• Economic growth (increase in real GDP).
• Low unemployment.
• Low and stable inflation.
• Equitable distribution of income (fairness).
• External balance (stable current account).

5.2 Fiscal Policy

5.3 Monetary Policy

5.4 Supply‑Side Policies

• Improve resource quality: education & training, health care.
• Increase resource quantity: immigration, investment in infrastructure.
• Enhance efficiency: deregulation, privatisation, tax incentives for R&D.

5.5 Measuring the Macro‑Variables

6. Economic Development

6.1 Living Standards

• Real GDP per head – measures average income.
• Human Development Index (HDI) – combines income, education & health.
• Multidimensional Poverty Index (MPI) – looks beyond income.

6.2 Poverty

• Absolute poverty – cannot afford basic necessities (e.g., $1.90 a day).
• Relative poverty – income far below average in a society.
• Policies: cash transfers, micro‑credit, education programmes, health services.

6.3 Population Dynamics

• Growth rate = (Births – Deaths + Net migration) ÷ Population.
• Demographic transition – shift from high birth & death rates to low rates.
• Implications: labour supply, dependency ratios, pressure on services.

6.4 Cross‑Country Differences

• Factors influencing development: natural resources, institutions, political stability, openness to trade, technology.
• Evaluation: resource‑rich countries may suffer “resource curse” if institutions are weak.

7. International Trade & Globalisation

7.1 Comparative Advantage

• Country should specialise in producing the good with the lowest opportunity cost.
• Result: higher world output and gains from trade for all participants.

7.2 Benefits & Limits of Free Trade

• Benefits: larger markets, economies of scale, lower prices, technology transfer.
• Limits: terms of trade may be unfavorable, adjustment costs, possible loss of domestic industries.

7.3 Trade Restrictions

7.4 Foreign Exchange & Balance of Payments

• Exchange rate: price of one currency in terms of another (e.g., £/$).
• Determination: floating (market‑driven) vs fixed (pegged by government).
• Current account: trade in goods & services, income, transfers.
• Capital account: flows of investment (FDI, portfolio).
• Balance of payments must balance (current + capital = 0, after accounting for errors & omissions).

8. Exam Toolkit – How to Score Across AO1, AO2 & AO3

8.1 Understanding Assessment Objectives

• AO1 – Knowledge & Understanding: define terms, state facts, label diagrams.
• AO2 – Application & Analysis: explain cause‑effect, use diagrams to illustrate, compare alternatives.
• AO3 – Evaluation: discuss advantages/disadvantages, consider short‑run vs long‑run, weigh evidence, give a balanced judgement.

8.2 Command‑Word Guide

8.3 Structured Answer Template (for a 12‑mark question)

1. Introduce the concept and identify the relevant factor (AO1).
2. Explain the mechanism using a labelled diagram (AO2).
3. Analyse the impacts on at least two macro‑variables (e.g., output, unemployment, inflation) (AO2).
4. Evaluate by discussing benefits, costs, distributional effects and any long‑run considerations (AO3).
5. Conclude succinctly, linking back to the basic economic problem of scarcity and choice.

9. Practice Question & Model Answer (PPC Focus)

Question: A country discovers a large deposit of oil. Using a PPC diagram, explain how this discovery will affect the country’s production possibilities and discuss the likely macro‑economic consequences.

Model Answer (AO1‑AO3)

1. Identify the factor – a new natural resource (oil) increases the quantity of the factor “land”.
2. Diagram – draw a PPC for “Oil‑related goods” vs “Other goods”. Show an outward shift of the curve (arrow labelled “economic growth”). Mark points A (old PPC) and A’ (new PPC).
3. Explain the shift – more oil means more raw material and potential export revenue; the economy can now produce more of both goods (increase in potential output).
4. Consequences:

   • Higher potential output → rise in real GDP and living standards (AO2).
   • More factories and extraction sites → lower unemployment.
   • If oil is exported, terms of trade improve; domestic prices may rise (inflationary pressure) if demand outpaces supply.
   • Greater government revenue can be used for public services or to fund supply‑side policies.

5. Evaluation:

   • Growth may be concentrated in the extractive sector; other sectors might see limited benefits.
   • Risk of “resource curse” – over‑reliance on oil can make the economy vulnerable to price swings.
   • Environmental costs (pollution, carbon emissions) may offset some welfare gains.
   • In the long run, investing oil revenue in education and infrastructure can sustain growth; otherwise the boom may be short‑lived.

6. Conclusion – the oil discovery shifts the PPC outward, indicating economic growth, but the overall benefit depends on how the extra income is managed and on the sustainability of the oil sector.