BASIC ECONOMIC PROBLEM

“Economics is the social science that describes the factors that determine the production, distribution and
consumption of goods and services.” Economics as a study is the study of scarcity and how societies
allocate resources. It also examines how people balance their needs and wants.

The economic problem is the fundamental issue of scarcity, or having fewer resources than humans want
and needs. This problem affects all stakeholders in an economy, including consumers, producers, workers,
and governments.

CAUSES OF THE ECONOMIC PROBLEM

Finite resources: There are only a limited number of resources available.

Unlimited wants: Humans have many desires, some of which are non-essential.

CONSEQUENCES OF THE ECONOMIC PROBLEM

Choice making: People must decide how to use resources efficiently.

Higher prices: Scarce resources and products lead to higher prices.
Higher production costs: Producers must pay more to produce goods from scarce resources.
Resource allocation: Governments must decide if they will provide goods and services, or if they will
allow private firms to do so.

The Economic problem:

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The economic problem arises because resources are limited, while human wants are virtually unlimited.
This fundamental issue creates the need for making choices. Essentially, it revolves around the allocation
of scarce resources (such as land, labor, capital, and entrepreneurship) to satisfy the diverse needs and
wants of people.

Key aspects of the economic problem include:

1. Scarcity: There are not enough resources to produce everything people want. This scarcity forces
societies to make decisions about how to allocate these limited resources efficiently.
2. Choice: Since resources are limited, individuals, businesses, and governments must decide how to
use them in the best possible way, often prioritizing certain goods and services over others.
3. Opportunity cost: Every choice has a trade-off. When resources are allocated to one use, the
opportunity to use them elsewhere is forgone. This is known as opportunity cost—the value of the
next best alternative that is given up.

In essence, the economic problem is the challenge of satisfying infinite human desires with finite
resources, leading to the need for decisions, trade-offs, and prioritization.

The Nature of the Economic Problem

Resources: are the inputs required for the production of goods and services.

Scarcity: a lack of something (in this context, resources).

The fundamental economic problem is that there is a scarcity of resources to satisfy all human wants and
needs. There are finite resources and unlimited wants. This is applicable to consumers, producers,
workers and the government, in how they manage their resources.

Economic goods are those which are scarce in supply and so can only be produced with an economic cost
and/or consumed with a price. In other words, an economic good is a good with an opportunity cost. All
the goods we buy are economic goods, from bottled water to clothes.

Free goods, on the other hand, are those which are abundant in supply, usually referring to natural sources
such as air and sunlight.

The reward for capital is the interest it receives.

The supply of capital depends upon the demand for goods and services, how well businesses are doing,
and savings in the economy (since capital for investment is financed by loans from banks which are
sourced from savings).

The quality of capital depends on how many good quality products can be produced using the given
capital. For example, the capital is said to be of much more quality in a car manufacturing plant that uses
mechanization and technology to produce cars rather than one in which manual labour does the work.

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Capital mobility can depend upon the nature and use of the capital. For example, an office building is
geographically immobile but occupationally mobile. On the other hand, a pen is geographically and
occupationally mobile

Enterprise: the ability to take risks and run a business venture or a firm is called enterprise. A person who
has enterprise is called an entrepreneur. In short, they are the people who start a business. Entrepreneurs
organize all the other factors of production and take the risks and decisions necessary to make a firm run
successfully.

The reward to enterprise is the profit generated from the business.

The supply of enterprise is dependent on entrepreneurial skills (risk-taking, innovation, effective

communication etc.), education, corporate taxes (if taxes on profits are too high, nobody will want to start
a business), regulations in doing business and so on.

The quality of enterprise will depend on how well it is able to satisfy and expand demand in the economy
in cost-effective and innovative ways.

Enterprise is usually highly mobile, both geographically and occupationally.

All the above factors of productions are scarce because the time people have to spend working, the
different skills they have, the land on which firms operate, the natural resources they use etc. are all in
limited in supply; which brings us to the topic of opportunity cost.

Opportunity Cost

The scarcity of resources means that there are not sufficient goods and services to satisfy all our needs
and wants; we are forced to choose some over the others. Choice is necessary because these resources
have alternative uses- they can be used to produce many things. But since there are only a finite number
of resources, we have to choose.

When we choose something over the other, the choice that was given up is called the opportunity cost.
Opportunity cost, by definition, is the next best alternative that is sacrificed/forgone in order to satisfy the
other.

Example 1: the government has a certain amount of money and it has two options: to build a school or a
hospital, with that money. The govt. decides to build the hospital. The school, then, becomes the
opportunity cost as it was given up. In a wider perspective, the opportunity cost is the education the
children could have received, as it is the actual cost to the economy of giving up the school.

Example 2: you have to decide whether to stay up and study or go to bed and not study. If you chose to go
to bed, the knowledge and preparation you could have gained by choosing to stay up and study is the
opportunity cost.

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Production Possibility Curve Diagrams (PPC)

Because resources are scarce and have alternative uses, a decision to devote more resources to producing
one product means fewer resources are available to produce other goods. A Production Possibility Curve
diagram shows this, that is, the maximum combination of two goods that can be produced by an economy
with all the available resources

The PPC diagram above shows the production capacities of two goods- X and Y- against each other.
When 500 units of good X are produced, 1000 units of good Y can be produced. But when the units of
good X increases to 1000, only 500 units good Y can be produced.

Let’s look at the PPC named A. At point X and Y it can produce certain combinations of good X and good
Y. These are points on the curve- they are attainable, given the resources. Th economy can move between
points on a PPC simply by reallocating resources between the two goods.

If the economy were producing at point Z, which is inside/below the PPC, the economy is said to be
inefficient, because it is producing less than what it can.

Point W, outside/above the PPC, is unattainable because it is beyond the scope of the economy’s existing
resources. In order to produce at point W, the economy would need to see a shift in the PPC towards the
right.

For an outward shift to occur, an economy would need to:

Discover or develop new raw materials. Example: discover new oil fields

Employ new technology and production methods to increase productivity

Increase labour force by encouraging birth and immigration, increasing retirement age etc.

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An outward shift in PPC, that is higher production possibility, will lead to economic growth.

In the same way, an inward shift can occur in the PPC due to:

Natural disasters, that erode infrastructure and kill the population

Very low investment in new technologies will cause productivity to fall over time

Running out of resources, especially non-renewable ones like oil or water

An inward shift in the PPC will lead to the economy shrinking.

How is opportunity cost linked to PPC?

Individuals, businessmen and the government can calculate the opportunity cost from PPC diagrams. In
the above example, if the firm decided to increase production of good Y from 500 to 750, it can calculate
the opportunity cost of the decision to be 250 units of good X (as production of good X falls from 1000
to 750). They are able to compare the opportunity cost for different decisions

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