Chapter 3- The Economic Problem
The Basic Economic Problem: Scarcity
The basic economic problem arises because resources (inputs used to produce goods and services) are scarce
while people’s wants are unlimited. Wants are unlimited because there is always likely to be something else that a
person wants whatever their income. As a result, individuals, firms and governments have to make choices due to
the scarcity of resources. People have to make a choice on how to allocate scarce resources between many
competing uses to satisfy unlimited wants. Thus, there will be an opportunity cost each time a choice is made.
Thus, given limited resources and unlimited wants, individuals, firms and governments have to choose which wants
to satisfy. They have to make a choice between alternative wants. For instance, Consumers have to decide what to
buy, workers – which jobs to do, firms – what to produce, governments – what to spend tax revenue on. Having to
select one option involves an opportunity cost. Opportunity cost is the best alternative forgone when a decision is
made.
The resources of a country are referred to as ‘factors of production’. Four factors of production may be identified:
Land: includes all natural resources, raw materials, the fertility of the soil and resources found in the sea.
The reward for land is the rent it receives.
Labour: refers to those involved in the production of goods and services and includes all human effort, both
physical and mental. The reward for labour is wages and salaries.
Capital: any man-made aid to production including factory buildings, offices, machinery and IT equipment
that is used to make other goods and services. The reward is the interest it receives.
Enterprise: the entrepreneur performs two essential functions:
✓ bringing together the other factors of production so that goods and services can be produced
and
✓ taking the risks involved in production.
The reward for enterprise is profit or loss.
The issue of scarcity means that societies face a series of three questions:
a) What to produce?
Economies cannot produce everything, so they must decide what to produce and in what quantities. For
example, firms and governments have to choose whether to produce lots of goods and services, such as
food, clothing and vehicles, to improve the standard of living, or whether to produce lots of military
equipment to improve national defence.
b) How to produce?
Firms need to consider how they can get the maximum use out of the resources available. Sometimes firms
need to consider issues other than purely economic concerns when deciding how to produce. It may be that
an economy could produce more goods and services by using cheap labour, but there may be moral
objections to the use of cheap labour.
c) For whom to produce? Governments have to decide whether everyone is going to have a more or less
equal share of what is produced or whether some will have more than others. Some economies aim to
create a more equal society through policies that redistribute wealth and income from the rich to the poor.
There are other economies, by contrast, that have extreme inequalities of income and wealth, often based
upon inheritance.
The Distinction Between Renewable and Non-Renewable Resources
Renewable resources can be used repeatedly and naturally replenished, for example wind generated
electricity
Non-renewable resources cannot be naturally replenished at a pace that keeps up with consumption.
continued consumption will eventually result in their exhaustion. For example, oil and coal
The Importance of Opportunity Costs to Economic Agents (Consumers, Producers and Government)
Opportunity cost is the loss of the next best alternative forgone when making a decision.
Due to the problem of scarcity, choices have to be made about how to best allocate limited resources amongst
competing wants and needs. Each choice involves an opportunity cost. This may be explained as follows: if a
country’s resources are used to manufacture one product, then it must forgo an alternative product that could have
been produced. The next best alternative forgone is called the opportunity cost of what has been produced.
Opportunity cost and consumers
When a consumer chooses to purchase a new phone, they may be unable to purchase new jeans. The jeans
represent the loss of the next best alternative forgone (the opportunity cost)
Opportunity cost and producers
When a producer decides to allocate all of their resources to producing electric vehicles, they may be unable to
produce petrol vehicles. The petrol vehicles represent the loss of the next best alternative (the opportunity cost).
Opportunity cost and government
When a government decides to provide free school meals to all primary students in the country, they may be unable
to fund some rural libraries which may have to close. The libraries represent the loss of the next best
alternative (the opportunity cost)