THE ECONOMIC PROBLEM

What is Economics?
 Economics is the study of how human beings strive to satisfy unlimited human wants
using limited resources.
 Economics is the study of how society uses its scarce resources.

Definition of key terms used in Economics

 Resources: It refers to factors of production that are used in the production of goods and
services.
They are divided into three main categories
Natural resources e.g. Land, Rivers,
Man-made resources e.g. Machines and Buildings
Human resources e.g. Labour, Human capital and Entrepreneurship
 Choice: Refers to selection of an item from a list of many other items
 Scale of preference: Refers to a list of items starting from the most important item to the least
important item.
 Economic goods: Goods that are scarce and only available at cost or price
Characteristics of economic goods:
o Scarce in supply: Scarcity means not available in sufficient quantities i.e. limited in
supply.
o Have money value: The value of a commodity is expressed through its price (exchange
value).
o Unevenly distributed: Are available in varying quantities at different places. For
examples, minerals such as gold are not found everywhere.
 Free goods: Plenty in supply and are available at no cost. They are gifts of nature. Examples
include rain, air, sunshine, and wind.
 Opportunity cost: Refers to the second best alternative forgone after a person has made a
choice while trying to satisfy a want. This cost arises because a sacrifice has to be made
when making a choice.
Example of opportunity cost

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 E.g. if a person has £5 to either buy a pen or a book , if he chooses to buy a pen with the
amount of money that he has, the opportunity cost of buying a pen is a book. If he
chooses to buy a book with the amount of money that he has, the opportunity cost of
buying a book will be a pen.
 Non-renewable resources: Are those resources whose supply cannot be restored after use.
Using these resources leads to their exhaustion. For example, after mining gold and
exhausting the mine, it will be impossible to restore the supply of gold in that mine.
 Renewable resources: Are those resources whose supply can be restored and if they are not,
creating of goods and services is reduced and it may stop altogether. Examples are wood,
fuel, hydroelectric power, solar energy, and soda ash.
 Economic agents: Refers to households, firms and the government that operate in the
economy.

The Problem of Scarcity

Finite Resources
Finite (scarce) resources – the quantity available of these resources are limited. These resources
are referred to as the four factors of production: land, labour, capital and entrepreneurship.
Needs are the basic requirements for human survival. Some of these needs are physical and
include water, food, warmth, shelter and clothing.
Wants are goods and services that are not necessary for survival but make life more comfortable.
E.g. holidays abroad, more meals out and a bigger car. These wants are unlimited or infinite.

The Economic Problem

The basic economic problem is concerned with how best to allocate scarce resources in order to
satisfy people’s unlimited wants.
Basic economic problem occurs because the world’s resources are scarce or finite and peoples’
wants are infinite. Demand for resources is greater than their supply.

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 Figure: The basic economic problem
To overcome the basic economic problem, important decisions have to be made.
1. What to produce?
Because it is impossible to produce all the goods that people want, a country must decide which
goods will be produced. For example, should resources be used to provide more libraries, build
more schools, employ more teachers, make more cars, or train more doctors?
2. How to produce?
Goods can be produced using a variety of different production methods. The four factors of
production can be organized in different ways to produce the same goods.
3. For whom to produce?
Once goods have been produced, there has to be a method of distribution. This means that goods
have to be shared in some way between members of the population. For example, should
everyone get exactly the same quantities or should some receive more than others?

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