The Economic Problem

If you condensed Economics down to one statement it’d be something like: Economics
is all about satisfying infinite wants and needs with limited resources.

Economics — how best to satisfy Infinite Desires using Limited

Resources

1) Everyone has certain basic needs in life — e.g. food, water, a place to live, and so
on.
Everyone also has an infinite list of things they want — e.g. designer clothes,
smartphones, holidays, houses.
2) However, there’s a limited amount of resources available to satisfy these needs and
wants (i.e. resources are scarce).
3) These facts lead to the basic economic problem:

How can the available scarce resources be used to satisfy people’s infinite needs
and wants as effectively as possible?

The scarce resources (inputs) used to make the things people want and need (outputs)
can be divided into four factors of production. These factors are: Land, Labour,
Capital and Enterprise.

There are Four Factors of Production

Land: including all the Natural Resources in and on it

Labour: the Work done by People
Capital: Equipment used in producing goods and services
Enterprise: willingness to take a Risk to make a Profit

land
As well as actual ‘territory’, land includes all the Earth’s natural resources:
• non-renewable resources, such as natural gas, oil and coal
• renewable resources like wind or tidal power, or wood from trees
• materials extracted by mining (e.g. diamonds and gold)
• water
• animals found in an area

1) Nearly all things that fall under the category of ‘land’ are scarce — there aren’t
enough natural resources to satisfy the demands of everyone.
2) One exception is air, but even this isn’t as simple as it first looks...
• Air is not usually considered a scarce resource — there’s
enough for everyone to have as much as they want.
• But this doesn’t mean all air is equally good — air can
be polluted, as can be seen in a lot of big cities.
• In fact, the environment is considered by some people to be a scarce
resource.

Labour
1) Labour is the work done by those people who contribute to the production process.
The population who are available to do work is called the labour force.
2) There’s usually also a number of people who are capable of working and who are
old enough
to work, but who don’t have a job. Economists refer to these people as unemployed.
3) There are also people who aren’t in paid employment but still provide things people
need or want,
e.g. homemakers.
4) Different people have different levels of education, experience or training. These
factors can make some people more ‘valuable’ or productive in the workplace than
others — they have a greater amount of human capital
Capital
1) Capital is the equipment, factories and schools that help to produce goods or
services.
2) Capital is different from land because capital has to be made first.
3) Much of an economy’s capital is paid for by the government — e.g. a country’s road
network is a form of capital

Enterprise (entrepreneurship)

Enterprise refers to the people (entrepreneurs) who take risks and create things from
the other three factors of production.
1) They set up and run businesses using any of the factors of production available to
them.
2) If the business fails, they can lose a lot of money. But if the business succeeds, the
reward for their risk-taking is profit.

Scarcity requires the Careful Allocation of Resources

1) Economic activity involves combining the factors of production to create outputs

that people can consume.
The purpose of any economic activity is to increase people’s economic welfare by
creating outputs that
satisfy their various needs and wants.
2) In Economics a wide range of things count as economic activity.
3) One form of economic activity is the making of goods and the provision of services
(i.e. creating outputs).
 GOODS: ‘Physical’ products you can touch — such as washing machines, books
or a new factory.
SERVICES: ‘Intangible’ things — such as medical check-ups, teaching, or train
journeys.

4) Consumption (i.e. buying or using) is also a form of economic activity. When you
consume something, you’re trying to satisfy a need or a want. You can consume both
goods and services
5) Since there’s an endless array of things that could be produced and consumed,
but only limited resources, this leads to three fundamental questions:
What to produce?
How to produce it?
Who to produce it for?

Production Possibility Frontiers

Production possibility frontiers (PPFs) — also known as production possibility curves
(PPCs) or production possibility boundaries (PPBs) — show the maximum amount of
two goods or services an economy can produce.

Production Possibility Frontiers show the Maximum possible

output

The basic problem in Economics is how best to allocate scarce resources. A

production possibility frontier (PPF) shows the options that are available when you
consider the production of just two types of goods or services.

The PPF below shows the maximum number of houses (on the horizontal axis) and
vehicles (on the vertical axis) that can be made, using the existing level of resources in
an economy.
 2) Points A, B, C and D (and every other point on the PPF) are all achievable without
using any extra resources.
However, they are only achievable when all the available resources are used as
efficiently as is actually possible.
• Notice how, as you move along the curve from A to B, you’re building more
houses (about 22 500 instead of
1000) but fewer vehicles (80 000 instead of 120 000).
• Moving along the curve from A to B like this corresponds to allocating more
resources to the production of houses, and fewer resources to the production of
vehicles.
• In other words, there’s a trade-off between ‘building more houses’ and ‘making
more vehicles’
— to do more of one, you have to do less of the other.

A trade-off is when you have to choose between conflicting objectives because you
can’t achieve all your objectives at the same time. It involves compromising, and
aiming to achieve each of your objectives a bit. A trade-off is when you have to choose
between conflicting objectives because you can’t achieve all your objectives at the
same time. It involves compromising, and aiming to achieve each of your objectives a
bit.
Opportunity Cost is the next best thing that you’re forced to give up

1) The trade-off described above involves an opportunity cost.

2) An opportunity cost is what you give up in order to do something else — i.e. it’s the
cost of any choice that’s made.

3) So moving from A to B on the PPF above means you have the opportunity to build 21
500 extra houses as long as you give up the opportunity to make 40 000 vehicles. In
other words, the opportunity cost of building 21 500 extra houses is the lost production
of 40 000 vehicles.

The opportunity cost of a decision is the next best alternative that you give up in
making that decision.

4) Opportunity cost is a key concept in Economics which is used to ensure a more

efficient allocation of resources.
For example, consumers use the concept to choose what to spend their income on;
producers use it to look at the profit forgone by not making an alternative product;
and governments use it to look at the lost value to society from the policies they
choose not to implement.

5) However, there are some problems with using the concept of opportunity cost:
Often, not all alternatives are known.
Some factors don’t have alternative uses.
There may be a lack of information on alternatives and their costs.
Some factors (e.g. land) can be hard to switch to an alternative use.

For example, consumers use the concept to choose what to spend their income on;
producers use it to look at the profit forgone by not making an alternative product;
and governments use it to look at the lost value to society from the policies they
choose not to implement.