The Economic Problem

Scarcity and Choice

Humans seem to have an unlimited desire to consume more goods and services. However much we have, we want more. This is the main reason why economic growth is one of the major concern of governments; a bigger economy enables us to enjoy higher incomes and consume more.

But the resources we have to produce the goods and services are finite (limited). Therefore we can’t have everything we want. The reality of unlimited wants together with limited resources creates the problem of scarcity __and the need to exercise __choice. This is the fundamental problem in economics. It is concerned with using the resources we have to maximise the satisfaction of our wants, and therefore making the most appropriate choices of what to have, and what to go without. This is called economising.

Free Goods, Economic Goods and Opportunity Cost

Nearly all the goods and services we consume use up resources to provide them, and these resources could have been used for another purpose. For instance, the steel used in making a car could have made washing machines instead.

So when we use resources for one purpose, we have to give up something else. Opportunity cost is defined as ‘the sacrifice of the next best alternative use of resources’. It is what we have to go without when we make a choice. The challenge to individuals, firms and governments is to make those choices in ways which minimise the opportunity cost. This is why for instance, that cars have progressively become more fuel efficient. It enables us to make journeys at lower opportunity cost. By using less petrol, we will have money to spend on something else.

The Economic Problem, figure 1

Goods which use up resources that have an alternative use are called economic goods. They have an opportunity cost.

There are a few goods that economists call free goods.These have no opportunity cost. We can consume as much as we like and not have to give up something else. An example might be fresh air on top of a mountain; you can breathe as much as you like of it. Sand in the Sahara desert is another. Both these examples are things provided by nature; no resources are used up to make them.

But note that not all air is a free good. To pump up your tyres in a garage, air has to be compressed, which uses resources. Equally, sand for building has to be transported, which uses resources.

Economic goods generally command a price; people are prepared to pay to have them. Free goods don’t command a price.

Note that scarcity is a relative concept; until the 20th century the world had little use for oil, so it was not scarce. Now it is used as fuel for transport and heating as well as providing the raw material for agricultural fertiliser and many types of plastic.

Economic Resources (Factors of Production)

There are four main types of resources used to make goods and services:

  1. __Land __means any naturally occurring resource, not just the surface of the earth. It includes all mineral deposits, the content of the oceans (such as fish), and climatic conditions (such as sun and wind) that can be used to satisfy economic wants. We can distinguish between renewable and non-renewable natural resources. The former, such as wind and sun, are self replacing and inexhaustible. The latter, such as coal or natural gas may take millions of years to replace, and so are depleted as we use them. Some resources, like forests and fish are renewable to a certain extent, as they can regenerate, provided we don’t use them up too fast. Resources which can be exploited without fear of them running out are called sustainable resources.
  2. Capital __is a man-made resource. __Fixed capital refers to the stock of machines, buildings, vehicles, power stations, roads and so on that are used in the production process. These resources last for a long time before they have to be replaced. Working capital refers to man-made resources which will be used up in the production process, such as materials and components.
  3. Labour is the human effort that is used to make goods and services. It includes both physical and mental work. Labour can be made more productive through training and education, leading to workers with more skills and knowledge. A nation’s stock of skilled and educated workers is sometimes called its human capital.
  4. Entrepreneurship (or enterprise) is the skill and know-how of combining the other three factors of production. It involves skills of organisation and risk taking.

The Economic Problem, figure 1

Factors of production earn rewards (income) for their owners. Labour is generally rewarded with wages,but workers may sometimes share in a distribution of a company’s profits. The owners of businesses, (the entrepreneurs) receive most of the profits, but also bear any losses. The ownership of some resources, such as land, buildings or machines, can also generate an income in the form of rent.

What, How and for Whom?

The Fundamental Questions in Economics

Every society has to answer these three questions to provide for its material wants. In doing so we create an economy, which can rely on the free market, state provision, or some mixture of the two.

__What to produce? __This means the quantity and variety of goods and services. How many cars (and what types), how much wheat etc..

__How to produce? __This is about organising and combining factors of production to produce the goods we want. Should we generate electricity from fossil fuels, nuclear reactors or wind farms? Where are we going to locate airports or car factories?

__For whom to produce? __How will we share out the goods and services produced amongst the population? Will we all get the same, or will some get more than others?

How we answer these questions will determine the kind of economic system we live under.