Welcome to Economics 9640: The Economic Problem

Hello! Welcome to the very foundation of Economics. This chapter, Scarcity, choice and the allocation of resources, explains why the subject of Economics even exists.
If resources were unlimited, there would be no need for tough decisions. But because they are limited, we constantly face choices. Understanding this fundamental problem is the key to mastering everything else in the curriculum.

1. The Nature and Purpose of Economic Activity (Syllabus 3.1.1.1)

Economists study how societies manage their limited resources. But what is the ultimate goal of all this management?

The Central Purpose: Satisfying Needs and Wants

The central purpose of economic activity is the production of goods and services to satisfy human needs and wants.

  • Needs: These are things essential for survival (e.g., basic food, shelter, water).
  • Wants: These are desires that are not essential for survival but improve the quality of life (e.g., a fast car, holidays, the latest smartphone).

Did you know? While our resources are limited, human wants are often considered to be unlimited. We always want more or something better!

The Three Key Economic Decisions

Because we cannot satisfy all wants, every economy, whether large or small, must answer three basic questions:

  1. What to produce? Should a country produce more hospitals (services) or more missiles (goods)? More food or more fuel?
  2. How to produce? Should factories use more machines (capital-intensive methods) or more human workers (labour-intensive methods)?
  3. Who is to benefit from the goods and services produced? How will the final products be distributed? This question touches upon income, wealth, and economic welfare (the overall well-being of individuals in the economy).

Key Takeaway: Economics is the study of how people organize themselves to satisfy endless wants with scarce means, focusing on what, how, and for whom to produce.


2. Economic Resources: The Factors of Production (Syllabus 3.1.1.2)

The resources available to produce goods and services are known as Factors of Production (FOPs). Economists classify them into four main categories:

  1. Land: This covers all natural resources. It includes not just the physical land itself, but also everything that comes from the ground or nature (e.g., oil, coal, water, fish stocks).
    • Reward: Rent
  2. Labour: The human effort—mental and physical—used in production. The size and quality of the workforce matter hugely.
    • Reward: Wages
  3. Capital: Human-made goods used to produce other goods and services (e.g., machinery, factories, roads, computers). Financial capital (money) is not usually counted here; we mean physical capital.
    • Reward: Interest
  4. Enterprise (Entrepreneurship): The special human skill that organizes the other three factors (Land, Labour, and Capital) and takes the financial risk of production.
    • Reward: Profit
Memory Aid: LLCE

Remember the four Factors of Production easily: Land, Labour, Capital, Enterprise.

Renewable, Non-Renewable, and the Environment

We must also consider the nature of these resources:

  • Renewable resources can be replaced or replenished naturally over time, provided they are not over-exploited (e.g., solar energy, timber, fish populations).
  • Non-renewable resources are finite; once used up, they cannot be replaced (e.g., oil, natural gas, coal).

The environment is a scarce resource. Economic activity (production and consumption) relies heavily on the environment (for inputs like raw materials) and can also severely damage it (through pollution and resource depletion). Economists must consider these environmental trade-offs.

Key Takeaway: Resources are classified as Land, Labour, Capital, and Enterprise. Their availability, especially natural resources, directly limits our ability to produce.


3. The Fundamental Economic Problem: Scarcity and Choice (Syllabus 3.1.1.3)

This is the heart of the matter.

Scarcity

Scarcity is the fundamental economic problem that exists because human wants are unlimited, but the resources available to satisfy them are limited.
Because of scarcity, we are forced to make choices.

Opportunity Cost: The Cost of Choosing

Every time a choice is made, something else must be given up. This "thing given up" is the real cost in Economics.

  • Opportunity Cost is the cost expressed in terms of the next best alternative forgone (given up).

Example: Imagine a government has £10 billion. They can choose to spend it on building either a new high-speed rail network OR 20 new hospitals. If they choose the rail network, the opportunity cost is the 20 new hospitals they had to give up.
Trick: Always ask yourself, "What was the second-best thing I could have done with that money/time/resource?" That's your opportunity cost!

Resource Allocation Systems

Since resources are scarce, society must have a system to decide how resources are allocated (distributed) between competing uses. There are three main ways this is done:

1. Free Market Economy (or Capitalist Economy)

  • Resources are primarily owned by private individuals and firms.
  • Decisions (What, How, For Whom) are driven by the price mechanism (supply and demand).
  • Example: The price of smartphones goes up, signalling to producers that more should be made.

2. Centrally Planned Economy (or Command Economy)

  • Resources are owned and controlled by the government (the state).
  • Decisions (What, How, For Whom) are made by central planning bodies.
  • Example: Historical Soviet Union or North Korea.

3. Mixed Economy

  • This is the most common system in the world (e.g., UK, USA, China).
  • Resources are allocated by both the price mechanism (the market) AND government intervention.
  • The government usually intervenes to provide essential services (like policing or education) or to correct market failure.

Key Takeaway: Scarcity forces choice, and choice always involves an opportunity cost. Societies use different economic systems (Free Market, Mixed, or Planned) to decide how these scarce resources are allocated.


4. Production Possibility Diagrams (PPDs/PPFs) (Syllabus 3.1.1.4)

Don't worry if diagrams seem tricky! The Production Possibility Diagram (PPD), also known as the Production Possibility Frontier (PPF), is just a visual tool to illustrate scarcity, choice, and opportunity cost.

It shows the maximum possible output combinations of two goods or services that an economy can achieve when all resources are fully and efficiently employed.

What the PPD Illustrates

Imagine an economy that can only produce two things: Cars and Wheat.

  • Scarcity: The PPD creates a boundary. You cannot produce outside this boundary (points outside are currently unattainable).
  • Choice and Trade-offs: To move from producing more Cars to producing more Wheat, the economy must "trade off" some cars.
  • Opportunity Cost: The opportunity cost of producing more Wheat is the number of Cars you have to give up (the slope of the curve). If the curve is bowed outwards, this shows that opportunity cost increases as production increases (because resources are not perfectly adaptable).
Points on the Diagram

A. Points on the Boundary (The Frontier):

All points lying on the PPF boundary are productively efficient. The economy is using all its available FOPs to maximum capacity.

B. Points Inside the Boundary:

Points inside the PPF represent inefficiency or unemployment of economic resources.
Example: If many factories are sitting idle or many people are unemployed, the economy is operating inside the PPF.

C. Points Outside the Boundary:

Points outside the PPF are currently unattainable. They represent future production goals. To reach them, the economy must experience economic growth (the PPF shifts outwards).

Efficiency: Productive vs. Allocative
  • Productive Efficiency: This occurs when production takes place using the fewest resources possible. All points on the PPF are productively efficient.
  • Allocative Efficiency: This occurs when resources are allocated in a way that produces the combination of goods and services most wanted by society.
    Important: Just because a point is on the boundary (productively efficient) doesn't mean it's the *right* combination for society (allocatively efficient). We need to know what consumers truly desire.

Key Takeaway: The PPD visually demonstrates scarcity, opportunity cost, and the difference between simply being efficient (on the curve) and achieving full potential (shifting the curve outward, which is economic growth).


5. Economic Methodology (Syllabus 3.1.1.5)

Economics is not a science like Physics or Chemistry, but it uses similar logical methods.

Economics as a Social Science

Economics is a social science. This means it studies human behaviour and societal arrangements, making it different from natural sciences (like physics) because human actions are often unpredictable and subject to emotion and bias.

Positive vs. Normative Statements

Economists try to be objective, but they must often deal with opinionated issues. This distinction is crucial for exams:

  • Positive Statements: These are objective, factual claims that can be tested, verified, or refuted using data or evidence.
    Example: "A 10% increase in the minimum wage will lead to 50,000 job losses." (We can test this data.)
  • Normative Statements: These are subjective claims based on value judgements (opinions) and cannot be tested. They often contain words like 'ought', 'should', 'better', or 'fair'.
    Example: "The government should increase the minimum wage because it is the fairest thing to do." (Fairness is an opinion.)

Memory Tip: Positive = Provable. Normative = Not provable (Value Judgement).

The Role of Value Judgements

While positive economics informs policy, value judgements heavily influence economic decision-making and policy choices.

  • People's views on the "best option" are influenced both by the positive consequences (the predicted factual results) and by moral or political judgements (what they believe is ethically right or fair).
  • For example: Economists might agree (positively) that taxing sugary drinks reduces consumption, but whether the government *should* implement such a tax depends on the normative value judgement about the government's role in personal health.

Key Takeaway: Economists rely on testable Positive Statements, but policy decisions are ultimately shaped by untestable Normative Statements and ethical Value Judgements.


Quick Review Box: The Fundamentals

Scarcity: Unlimited wants + Limited resources.
FOPs: Land, Labour, Capital, Enterprise.
Opportunity Cost: Next best alternative forgone.
PPD Boundary: Productively Efficient (use of resources).
Positive vs. Normative: Facts vs. Opinions.