The Basic Economic Problem

1.1.3 The Economic Problem

The basic economic problem is scarcity.

Scarcity means there are unlimited wants but only limited resources to satisfy them.

This problem affects individuals, firms, and governments, and exists even in wealthy countries.

The factors of production are the resources used to make goods and services.

There are four main factors:

1) Land – All natural resources used in production, such as oil, minerals, water, and forests.

The payment for land is called rent.

2) Labour – The human effort, both physical and mental, used to produce goods and services.

The payment for labour is called wages.

3) Capital – Man-made resources used to make other goods and services, such as machines, tools, and buildings.

Capital does not mean money. The payment for capital is called interest.

4) Enterprise – The entrepreneur who organises land, labour, and capital and takes risks to make a profit.

The payment for enterprise is profit.

Because resources are scarce, choices must be made.

Every choice means giving something else up.

Consumers choose what to buy to get the most satisfaction from their income.
Firms choose what to produce and how to produce it with their limited resources.
Governments choose how to spend tax revenue on services like healthcare or education.

Scarcity means every society must answer three key questions:

1) What to produce?

Should we produce more consumer goods or more military goods?

2) How to produce?

Should we use more workers (labour-intensive) or more machines (capital-intensive)?

3) For whom to produce?

Who should receive the goods — those who can pay the most, or those in greatest need?

Every choice has a cost.

Opportunity cost is the value of the next best alternative given up when a decision is made.

Examples:

If a consumer buys a chocolate bar, they give up the cheese scone they could have bought instead.
If the government spends more on healthcare, it may have to spend less on education.