Basic Economic Ideas and

Resource Allocation
Scarcity, Choice & Opportunity Cost
 The fundamental economic problem: of scarcity arises due to unlimited human wants of
consumption exceeding finite economic resources for production.

 Consumption: is process by which consumers satisfy their wants.

 Production: is process of creating goods and services in an economy

 Economic goods – these are goods which require resources to be produced and obtained and
therefore have an opportunity cost. Allocative mechanism will be used to allocate such goods.
Ex. cars.

 Free goods – these are goods which do not require any resources to be produced and obtained
and therefore are abundant and have no opportunity cost. Ex. sunlight.

 Ceteris paribus is a Latin word meaning ‘all other things being equal’

 Needs are necessary, wants are not.

Thus, choices have to be made at all levels
Consumers – maximum satisfaction.
Producers – maximum profit.
Governments – maximum benefits.

 Choice: is the need to make decision about the possible alternative uses of scarce resources
due to scarcity. It gives rise to the concept of opportunity cost and the 3 basic economic
problems.

 Opportunity cost: is the cost of choosing something in terms of the benefit derived from the
best alternative forgone.

 Economic resources/factors of production: are inputs available for production of goods and
services.

 Positive and Normative Statements:

  Short run: time period when a firm can only change some and not all factor inputs.

 Long run: time period when all factors of production are variable

 Specialisation: the process by which individuals, firms and economies concentrate on

producing those goods and services where they have an advantage over others

 Economic structure: the way in which an economy is organised in terms of sectors.

Factors of Production

 Different economic systems answer the 3 basic economic questions differently.

 Note, that mixed economics try to gain advantages and avoid disadvantages of both market
and planned economies.
Comparison between market & planned economies

:
Transitional economy: is one which is in process of changing from a planned economy to a mixed
economy where market forces have greater importance.
• Issues of transition:
• Inflation.
• Industrial unrest.
• Fall in output.
• Unemployment.
• Balance of payments’ deficit.
• Reduction in welfare services.
Production Possibility Curves
Reallocation of resources: where resources are deliberately moved from one product to another.
Factor mobility: the ease by which factors of production can be moved around
Production possibility curve: is one which joins together the different combinations of products that
can be produced in an economy, over a period of time, given existing resources and technology.

 It is also known as production transformation frontier, boundary or a production

transformation curve. It demonstrates the ideas of choice, trade-offs and opportunity cost.
 Point inside curve indicates unemployment and point on curve shows full employment.
 This is productive efficiency.
 Point shifting occurs owing to allocative efficiency.
 Production point shifting from C to F requires a reallocation of resources to capital goods and
factor mobility determines the speed of this. This would act as an investment, shifting the
PPC to the right. This indicates economic growth.
 Factor mobility: is extent of reallocation of resources or ease of moving factors of production.
 Investment: is expenditure of capital goods, both fixed and working.
 Economic growth: is an expansion in the productive capacity in an economy.
(Lowering of long-run average cost, i.e., LRAC ensures this.)

Other causes of PPC shifting right:

 New resources.
 Increased labour supply.
 Improvements in human capital.
 Improved resource management.
 Privatisation.

 Straight PP line indicates constant opportunity cost which is next to impossible.

 Curved PP line indicates increasing opportunity cost which occurs when the extra production
of one good involves ever-increasing sacrifices of another as less suitable economic measures
have to be diverted into the production of the former, increasing marginal cost and decreasing
productivity.

Money
Money: is anything which is universally acceptable as a means of payment for goods and services.
Most money, except coins is ‘legal tender’ for settlement of debt.

Functions:
Medium of exchange.
Measure of value.
Standard for deferred payment.
Store of value.

Characteristics:
Advantages over barter:
Avoids double coincidence of wants.
Permits evaluation.
Enables giving change.
Eases saving.

Barter: is the direct exchange of one product for another. It was used before money.
Cash + Bank deposits = Money
Cash: includes the notes and coins in an economy. It is the most liquid form of asset.
Bank deposits: are money held in accounts with a financial institution, e.g. bank, building, society,
etc.
Liquidity: refers to the extent and ease of converting a non-cash asset into cash.
Near money: or ‘quasi-money’ are non-cash assets that can be quickly and easily converted into cash.
Cheques: are written instruction to a financial institution to pay an amount of money from an
account. So, they are means of payment through bank deposits, not money.

Classification of Goods & Services

Private goods: consumed by someone and not available to anyone else.
Public good: one that is non-excludable and non-rival and for which it is usually difficult to
charge a direct price.
Excludability: where it is possible to exclude one from consumption.
Non-excludable: where it is not possible to stop all benefiting from consumption.
Non-rival: as more consume, the benefit to those already consuming is not diminished.
Rivalry: where consumption by one person reduces availability for others.
Quasi-public good: goods that have some but not all of the characteristics of public goods
Free rider: someone who does not pay to use a public good
Merit good: one that has positive side effects when consumed.
Demerit good: one that has adverse side effects when consumed
Information failure: where people do not have full or complete information
Paternalism: a situation where society knows best and has some right to make a value
judgement.
Moral hazard: the tendency for people who are insured or otherwise protected to take greater
risks.
Adverse selection: where information failure results in someone who is unsuitable obtaining
insurance.

Key Concepts
1. What is meant by the fundamental economic problem of limited resources and unlimited
wants?
2. What is meant by scarcity and the inevitability of choices that have to be made by
individuals, firms and governments
3. What is meant by opportunity cost
4. Why the basic questions of what, how and for whom production takes place have to be
addressed in all economies
5. The meaning of the term ‘ceteris paribus’
6. What is meant by the margin and decision making at the margin
7. The importance of the time dimension in Economics
8. The difference between positive and normative statements
9. What is meant by factors of production, namely land, labour, capital and enterprise ■ what
is meant by the division of labour
10. How resources are allocated in market, planned and mixed economies
11. Problems of transition when central planning in an economy is reduced
12. The characteristics of a production possibility curve and how opportunity cost can be applied
13. The functions and characteristics of money and types of money
14. How goods can be classified into free goods, private goods, public goods, merit goods and
demerit goods
15. The problems associated with information failure.