1 Basic Economic Problem

Contents:
1. Learning Outcomes

2. Definitions

3. Scarcity, Choice, and Opportunity Cost

4. Factors of Production

5. Key Introductory Concepts

6. Introduction to Production Possibility Curves (PPC)

7. Division of Labour and Specialisation

8. Role of an Entrepreneur

9. Importance of Time Period

10. Public vs private goods

11. The Margin and Decision Making

12. Merit and Demerit goods

Candidates should be able to:

Learn what is entailed within the fundamental economic problem of limited
resources and unlimited wants

Identify the inevitability of choice that arises from scarcity

Learn what is meant by opportunity cost.

Know the difference between fact and value judgments.

Understand the meaning of the term, “ceteris paribus.”

Know the shape and shifts of the curve with differing opportunity costs.

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 Definitions
Resources Inputs available for the production of goods and services.

Wants Needs that are not always realised.

When the wants and needs of consumers exceeds the resources

Scarcity
available.

Choices have to be made by consumers, firms and governments as

Choice
resources are scarce.

Fundamental The consumers’ wants are unlimited and the resources to produce
Economic Problem the goods for those wants are scarce.

Factors of
Anything that aids the production of goods and services.
Production

Land The natural resources available in the economy.

Labour The human capital available in the economy.

Capital A man-made aid to production.

Entrepreneur The entity that organises production and takes risk.

Opportunity Cost The cost of the next best alternative foregone.

The time period where a firm can only change certain factors of
Short Run
production.

Long Run Time period where all factors of production are variable.

Very Long Run A time period where all key inputs of production are variable.

Positive Statement A statement based in empirical evidence.

Normative
A statement that is subjective about what may happen.
Statement

Production A diagrammatic representation of the maximum output a country

Possibility Curve can create when fully using all of its available resources.

Reallocation of When resources are deliberately moved from the production of one
Resources product to another.

The ease with which factors of production can be adapted to the

Factor Mobility
production process of different products.

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 1.1 Scarcity, Choice, and Opportunity Cost
1.1.1 Definition of Scarcity
Scarcity in economics is a term describing finite resources, or the perception of
limited resources, when there is not enough to fulfill human needs and wants.

1.1.2 Definition of Opportunity Cost

The opportunity cost of a choice is foregoing the next best alternative. The true
cost of any choices we have to make is expressed through the idea of opportunity
[Link] concept can be applied in various areas of economics and helps
economic agents such as households, firms, and the government in making
decisions.

1.1.3 Basic Economic Problem and their relationship

with Scarcity and Opportunity Cost
Economists first and foremost taught the “economic problem.” This is the
fundamental economic issue that arises, that is the impossibility of fulfilling the
unlimited wants of people with the limited resources. A result of this problem is
scarcity and due to this scarcity, we have to make choices.

1.2 Factors of Production

1.2.1 Factors of Production
In Economics we divide the resources available to us in four di erent categories,
known as the factors of [Link] of production are the resources used
in the production process. They are the inputs into production, including labour,
capital, land and enterprise

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 1.2.2 Definition of Land, Labour, Capital and Enterprise
Land:
Land is the natural resources available to us and comprises of the earth, lakes,
rivers, forests, mineral deposits below the earth, the climate above and any small
area of land that makes up a farm or factory. The reward of owning land is the
income generated from that land.
Labour:

Labour is the human factor of production, determined on various factors such as

the nation’s population, age and sex demographics, and the ability and willingness
to work. The reward earned by labour is the wage or salary paid to the labourers.
Capital:
Capital is any man-made aid to the production process. The reward that comes
from the employment of capital is interest.

Entrepreneur:

The entrepreneur is the organiser of all the factors of a product; he is the risk
taker that set everything in motion to turn the factors of production into actual
products. The reward for the entrepreneur is the profit made by the enterprise.

1.3 Key Introductory Concepts

1.3.1 Economic vs Free goods
Economic goods are those goods which use scarce resources in their production
while a free good is one that does not require scarce resources for its production,
and hence the marginal cost is zero. Free goods have a zero-opportunity cost.

Some goods, such as food and drink items are swiftly finished to satisfy a
consumer’s wants. These goods are classified as non-durable goods.

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 Other goods satisfy a consumer over a longer period of time, such as cars,
televisions, and refrigerators. These goods are known as consumer durables.

1.3.2 Durable vs Non Durable Goods

Some goods, such as food and drink items are swiftly finished to satisfy a
consumer’s wants. These goods are classified as non-durable goods. Other goods
satisfy a consumer over a longer period of time, such as cars, televisions, and
refrigerators. These goods are known as consumer durables.

1.3.3 Micro vs Macro

Microeconomics focuses on the unique choices made by people, businesses, or
specialised marketplaces.
Macroeconomics investigates how different economic factors interact at the level
of the entire economy.

1.3.4 Economics as a Social Science

Economics is social in the sense that it covers various elements of human
behaviour, specifically the decisions that humans need to undertake. It is a
science in the way it makes predictions that can be verified by using a variety of
theories and data, and it is social in that it is based on how individuals behave.

1.3.5 Positive and Normative Statements

Economics is a social science, meaning that there are both qualitative and
quantitative attributes and analysis that takes place in understanding and
explaining its concepts. Positive analysis is one that is birthed from empirical
evidence, that is, it is devoid of any value judgements.
When value judgements and opinions enter the domain of economic analysis, then
we are dealing with normative economics.

1.3.6 Ceteris Paribus

Ceteris Paribus is a Latin term used by economists to explain a situation where
there are no outside influences, apart from the direct factors taken into

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 consideration, or “other things remain equal.” This is done to simplify situations
and to pinpoint the effect of a single change in circumstances, so one economic
model can change at a time.

1.4 Introduction to Production Possibility

Curves (PPC)
1.4.1 Definition of Production Possibility Curve
The Production Possibility Curve (PPC) is an economic model used to depict
various micro- and macro-economic concepts. The PPC shows the different
combinations of two goods that could be produced in the economy, with a given
amount of resources and a fixed technological prowess.

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 1.4.2 Diagram of PPC and the concept it represents
The PPC depicts the issue of scarcity; it shows the maximum attainable
production of the economy. Any points beyond the PPC are unattainable as the
economy does not have the quantity of resources available to produce beyond
that output, because they are scarce.
Due to this prevailing scarcity of resources in the economy, producers have to
choose which goods and services get precedent and allocate resources to their
production.

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 If the economy is operating at a point inside the PPC, then inefficiencies are
rampant in the production processes. An increase in production efficiency will
lead to a combination of goods closer to the PPC.

Economic growth can result from an increase in the quantity or quality of

resources and technological development and enhancement that benefits the
production process of both manufactured and agricultural goods. This causes a
parallel shift outward.

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 However, if the increase in resources or technological breakthrough only benefits
the production process of one good, then we may see a pivotal shift outward. This
indicates that we will be able to significantly increase the production of only one
product.

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 1.4.3 Slope of the Production Possibility Curve and
Opportunity Cost
The PPC slopes downward due to the opportunity cost incurred in the decision to
produce more of one good over another, as resources have to be diverted and the
production of one good has to be sacrificed to produce another.

1.4.4 Types of shift in a PPC and the rationale behind

them
When resources are shifted from the production of one good to another, retraining
of the workforce and the adaption of certain machines and capital may be
needed. Factor mobility is the determinant of the extent of the reallocation
possible for a certain factor of production.

A PPC that is bowed outwards or is concave to the origin is caused by an

increasing opportunity cost. Increasing the production of one good will mean that
more and more of the other good will have to be sacrificed. This is due to the
resources being shifted later are less suited to the production in question.

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 In a linear PPC, the factors of production are equally suited to the production of
both goods. Therefore, we have a constant opportunity cost.

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 1.4.5 Application of the PPC
The production possibility curve can be used to diagrammatically depict some of
the real-world issues faced by economists and help them create solutions.

In the process of production, resources are consumed as well and must be

maintained if we want the same level of production to continue. Some resources
need to be earmarked for the creation of capital goods if we want production
possibilities to be maintained. This is also known as investment.

A choice must therefore be made between consumer and capital goods. A higher
number of consumer goods produced would result in a higher standard of living
for the population now, but a focus on the production of capital goods would
safeguard future generations from suffering a fall in their lifestyles for a sacrifice
in the now.

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 If we produce any amount of capital goods below the rate of capital goods used
up, then the economy’s capital goods stock will decline. The production
possibilities will diminish over time and there will be a parallel shift inward in the
future.

1.5 Division of Labour and Specialisation

1.5.1 Definition of specialisation
The economy can produce goods in a multitude of ways, one of which is
specialisation. Specialisation occurs when workers are assigned specific tasks
within a production process where they all focus on the production of goods they
are better at producing than their competitors.

Workers will require less training to be an efficient worker. Therefore, this will lead
to an increase in labour productivity and firms will be able to benefit from
economies of scale (lower average costs with increased output) and increased
efficiency. Specialisation leads to not only increased output, but increased
dependency.
The economic agent in question will produce whatever it has specialised in, in
excess, and then trade that excess for other goods and services.

1.5.2 Definition of Division of Labour

The scale of production has greatly increased over the centuries, and the
concentration of many workers in large production units have allowed producers
to dismantle the production process into a series of individual tasks. This is called
the division of labour.

1.5.3 The Advantages of the Division of Labour for

workers

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 Modern production processes attempt to inculcate the division of labour as much
as possible. Workers who specialise in a field can be more efficient during the
production process. Specialised workers can produce more output than other non
specialised workers. That's because these workers have gained much more
technical skills through experience and knowledge. Thus this leads to higher
productivity and increased output.

1.5.4 The Advantages of the Division of Labour for

firms
As workers become more specialised in performing a task during the production
process, their errors are significantly reduced. This reduces the waste that occurs
during production processes. Moreover, specialised workers can produce more
output than other workers, as it takes them less time. This contributes to bringing
down the cost of input for the firms, as these specialised workers produce more in
a shorter time. The division of labour makes it possible for new hires to quickly
take the position of departing workers. This lessens the effect of losing a worker
for a firm.

1.5.5 The Advantages of the Division of Labour for

consumers
A wider range of goods can be produced as a result of the division of labour. This
is so that employees may individually contribute to the manufacture of a variety of
items since they are each skilled in a certain task.
This increased ability to produce a variety of items encourages manufacturers to
produce a wider variety of goods, boosting competition and, eventually,
[Link] leads to increased consumer [Link] division of labour makes
production more cost-effective while simultaneously boosting productivity. This
results in less expensive goods as a result for the consumers.

1.5.6 Limitations of division of labour

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 Although the division of labour increases output and efficiency, it has several
disadvantages. As workers are required to focus on a specific job, this repetitive
work or doing the same job, again and again, can create monotony.
The work becomes boring, which leads to dissatisfaction and loss of interest.

This can lead to morale issues within the workforce as they are not able to
develop a plethora of skills. This then ultimately leads to a decrease in
productivity. Skilled employees may demand a high salary and other financial
benefits as compared to unskilled workers. Thus, this may increase administrative
expenses in the organisation.

Another disadvantage of specialisation is the lack of flexibility. If a specialist

worker is on leave, no one can take his position, which leads to disruption of work.
Moreover, since the employee knows only part of the job, he may become unfit for
another job. Therefore, when there is a downsizing of the company, he may face
problems in finding the same job in another factory.
Also, many workers feel like the production process has become dehumanised
with the abundance of robotics now prevalent.

1.6 Role of an Entrepreneur

1.6.1 Definition and role of enterprise
Entrepreneurs are individuals who take risks by providing goods in anticipation of
[Link] factor is considered crucial because it is responsible for organising
the other three factors of production, directing them along different production
[Link] and growing a business to its maturity is a traditional role for
entrepreneurs. Most businesses face some kind of uncertainty as they develop.
An entrepreneur's role in this aspect is to anticipate any challenges and address
them as quickly as [Link], entrepreneurs regularly seek out
opportunities that can grow or boost sales for their business.

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 1.6.2 Entrepreneurs and their relationship with
economic growth and innovation
Entrepreneurs boost economic growth by introducing innovative technologies,
products, and services. Entrepreneurship and innovation are closely related.
Innovation is essential for maintaining a company's marketability. A change-maker
who challenges the widely accepted reality and generates profit from it is referred
to as an innovative entrepreneur.

1.7 Importance of Time Period

1.7.1 What is a short run?
The short run is a concept that states that, within a certain period in the future, at
least one input is fixed while others are [Link] ability of a company to
change output or wages to maintain a profit rate is constrained in the short run by
leases, contracts, and wage agreements.

1.7.2 What is a long run?

The long run is a time frame during which all cost and production parameters are
variable. Over time, businesses are able to adjust all [Link] firms can be more
efficient in the long run as they have time to discern how it can produce most
successfully and efficiently. The firms may be able to be more flexible in the long
run, for example, by hiring more labour and installing new capital. Consumers may
require additional time to adapt to shifting market conditions or change their
purchasing patterns.

1.7.3 What is a very long run?

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 In the very long run, not just the factors of production, but other key inputs such
as technology also become variable. Technological advancements, government
regulations and social considerations can all change in this time dimension to
increase the productive capacity, efficiency, and production processes of a firm.
In a very long run time period, it is conceivable for supply to shift during this time
due to advancements in technology.

1.8 Public vs private goods

1.8.1 Definition of a Public good
Public goods are goods that are commonly available to all people within the
[Link] are non-excludable because everyone can use it. Once provided, we
cannot exclude others from using it which gives rise to the free rider problem.
A market failure known as the "free rider problem" occurs when consumers take
advantage of resources, products, or services without paying for them. Moreover,
these goods are non-rival because for any level of production the cost of
producing for additional consumers are zero.
One person does not deprive others from using it. Examples of public goods
include street lighting, a lighthouse, national defence etc.

1.8.2 Definition of a Private good

Private goods are those goods that are produced by the private [Link]
goods are traded in the market by the private firms to earn profit. They are
excludable because some people can be excluded from using [Link] who
can pay benefit from them.

They are rival because if the product is consumed by an individual , its availability
for others diminishes.

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 1.9 The Margin and Decision Making
1.9.1 What are Marginal Benefits
A marginal benefit is a maximum amount a consumer is willing to pay for an
additional good or service. It is the extra benefit from the consumption of a good.
Marginal Benefit: Change in Benefit / Change in Qty

ΔTB/ΔQ

1.9.2 What are Marginal Costs

Marginal cost is the extra cost of producing a good, usually measured in terms of
the price of the good.
Marginal Cost: Change in Cost / Change in Qty

ΔTQ/ΔQ

1.9.3 Relationship between Marginal Benefits and

Marginal Costs
In economics, to make rational choices, we put the marginal costs and marginal
benefits of any decision against each other.

If the marginal benefit of any activity exceeds its marginal costs, then the activity
should be approved and vice versa.

1.9.4 Relationship of Price and Quantity Produced with

Marginal Cost and Marginal Benefit
Production would not be financially viable if the marginal cost was higher than the
price. So long as the marginal cost and the sale price are equal, production will
continue.

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 Increasing marginal costs of production result in a positive relationship between
the price of a good and the total quantity of that good supplied to the marketplace.

The marginal benefit decreases with each additional unit consumed, thus the
person will be willing to pay less for each additional unit.

As a result, the law of demand is founded on the concept of declining marginal

benefit and states that there is an inverse relationship between price and quantity
demanded.

1.10 Merit and Demerit goods

1.10.1 Definition of a Merit good
Merit goods follow the characteristics of a private good. They are both rival and
exclusive.
They are rival because one person’s use denies someone else from having the
same good or service example as a hospital bed.

They are exclusive because consumption is dependent on payment. What

distinguishes them from the other private goods is that they have positive
externalities.
This means that they confer benefits of society that are greater than the benefits
enjoyed by the individuals consuming them.

Private sector will produce merit goods such as education and healthcare, taking
only the private cost and private benefits into consideration.

This is an instance of allocative inefficiency or market failure resulting from the

market under allocating [Link] intervenes by either subsidising or
directly providing education and healthcare to reduce market failure and improve
resource allocation.

Merit goods, if provided by the private sector will be under produced and
underconsumed.

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 1.10.2 Definition of a Demerit good
Demerit goods are private goods in that they are rival and exclusive.

What distinguishes them from the other private goods is that they have negative
externalities.
This means that they confer costs on the society in addition to the costs faced by
the individual consuming them. Such goods are considered socially desirable
goods.
This is because there is a diversion between social costs and private costs.

If left unregulated, the private sector would over produce and over consume these
goods, ignoring the negative [Link] intervene by imposing taxes,
regulating production and consumption of such goods.

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