Finite Resources & Unlimited Wants

 The basic economic problem is that resources are scarce

o In economics, these resources are called the factors of production

 There are finite resources available in relation to the infinite wants and
needs that humans have
o Needs are essential to human life e.g. shelter, food, clothing
o Wants are non-essential desires e.g. better housing, a yacht etc.

 Due to the problem of scarcity, choices have to be made by producers,

consumers, workers and governments about the best (most efficient) use of
these resources

 Economics is the study of scarcity and its implications for resource

allocation in society

All Stakeholders in an Economy Face the Basic Economic Problem

Consumers Producers Workers Government

 In a free  Producers  Workers may  Governments

market, selling want a more have to
scarcity has a products comfortable decide if they
direct made from & safer will provide
influence on scarce working certain
prices resources environment goods/service
 The scarcer a will find their but their s or if they
resource or costs of employers will allow
product, the production may not have private firms
higher the are higher the resources to provide
price than if they to create it them instead
consumers were selling  Their
will pay products decision
made from influences the
more allocation of
abundant resources in
resources society. E.g.
 If they
choose to
provide
national
healthcare,
fewer
Doctors will
be available
to work in
private
healthcare

Economic & Free Goods

 Economic goods are scarce in relation to the demand for them
o This makes them valuable
o Due to their value, producers will attempt to supply them in order to
make a profit
o Anything that has a price tag on it is an economic good e.g. oil, corn,
gold, trainers, watches and bicycles

 Free goods are abundant in supply

o Due to this abundance, it is not possible to make a profit from
supplying free goods
o Drinking water has been a free good for thousands of years, but as the
population increases & water sources become more polluted, it has
become an economic good
o E.g. sunlight, the air we breathe, sea water

The Factors of Production

 Factors of production are the resources used to produce goods & services
o Land, labour, capital & enterprise

 The production of any good/service requires the use of a combination of all four factors
of production
o Goods are physical objects that can be touched (tangible) e.g. mobile phone
 o Services are actions or activities that one person performs for another
(intangible) e.g manicure, car wash

The Four Factors of Production

Land Labour Capital Enterprise

Non-man-made The human input into Capital is any man- Enterprise involves
natural resources are the production made resource that is taking risks in setting
available for process. Labour used to produce up or running a firm.
production. Some involves mental or goods/services e.g. An entrepreneur
countries have a vast physical effort. Not all tools, buildings, decides on the
amount of a particular labour is of the same machines & computers combination of the
natural resource & so quality. It can be skilled factors of production
are able to specialise in or unskilled. Some necessary to produce
its production e.g. oil, workers are more goods/services with
wood, fish, corn, iron productive than others the aim of generating
ore because of the profit
education, training &
experience they have

Some of the Factors of Production Required to Produce a Motor Car

Land Labour Capital Enterprise

iron ore car designer robotic arms CEO

rubber production director conveyor belt
oil production line staff rolled steel
sand supply chain staff computers
cows seats
dashboards
mirrors
 leather
Rewards for the Factors of Production
 In a market economic system, the factors of production are privately owned by
households or firms (The terms 'market' & 'free market' are used interchangeably)
o They make these resources available to firms who use them to produce
goods/services
o Firms purchase land, labour, & capital from households in factor markets

 Households receive the following financial rewards for selling their factors of
production. This reward is called factor income
o The factor income for land → rent
o The factor income for labour → wages
o The factor income for capital → interest
o The factor income for entrepreneurship → profit

Definition of Opportunity Cost

 Opportunity cost is the loss of the next best alternative when making a decision

 Due to the problem of scarcity, choices have to be made about how to best allocate
limited resources amongst competing wants and needs

 There is an opportunity cost in the allocation of resources

o When a consumer chooses to purchase a new phone, they may be unable to
purchase new jeans. The jeans represent the loss of the next best alternative
(the opportunity cost)
o When a producer decides to allocate all of their resources to producing electric
vehicles, they may be unable to produce petrol vehicles. The petrol vehicles
represent the loss of the next best alternative (the opportunity cost)
o When a government decides to provide free school meals to all primary
students in the country, they may be unable to fund some rural libraries which
may have to close. The libraries represent the loss of the next best alternative
(the opportunity cost)

The Influence of Opportunity Cost on Decision Making

 An understanding of opportunity cost may change many decisions made by consumers,
workers, firms & governments
 Factoring the opportunity cost into a decision often results in different outcomes & so a
different allocation of resources
Examples of How the Consideration of Opportunity Costs Can Change
Decisions

Stakeholder Example

Consumer  Ashika is wanting to visit her best friend in Iceland

 She looks at flight prices from London to Reykjavík
 On Friday night it costs £120 whereas Thursday night is only
£50
 She is about to book the Thursday flight but then realises
that the opportunity cost of saving £60 on a flight is the
inability to work on Friday (loss of £130 income)
 Ashika books the more expensive flight. If she had booked
the cheaper flight, it would have cost her the income from
the missed day of work (£130) + £50 for the ticket

Worker

 Ric has been offered two jobs & is deciding which one to
accept
 Job A offers £400 a month more in salary than Job B, but
Job B offers the flexibility of working from home
 Most people would only consider the actual cost of
commuting before they make a decision, which in Ric's case
is £40 a week or £160 a month
 Ric values his free time & decides that each hour he can
save in commuting is worth £20 to him (£180 a week) - he is
considering the opportunity cost of commuting
 Ric decides to take Job B as the cost of monthly travel (4 x
£40) and value of the lost hours spent commuting (4 x
£180) adds up to £880 a month

Firm

 A firm selling organic avocados is offered a supply contract

by a large supermarket who wants to buy all of their stock
each month, but at a low price
 The supermarket is a prestigious customer
  The firm decides to not accept the contract as the
opportunity cost (loss of prestigious customer) is worth less
than the lost revenue to existing customers

Government

 The Australian Government has entered into a contract with

France to supply them with 8 submarines valued at $70bn
 The USA hears about it & pressurises Australia to buy the
submarines from them instead
 The Australian Government considers the opportunity cost
of denying the USA which includes less preferential deals
on other military hardware & general trade agreements
 They decide to break the contract with France & view this as
the approach that carries the lowest opportunity cost

Production Possibility Curves (PPC)

 The Production Possibility Curve (PPC) is an economic model that
considers the maximum possible production (output) that a country can
generate if it uses all of its factors of production to produce only two
goods/services

 Any two goods/services can be used to demonstrate this model

 Many PPC diagrams show capital goods & consumer goods on the axes
o Capital goods are assets that help a firm or nation to produce output
(manufacturing). For example, a robotic arm in a car manufacturing
company is a capital good
o Consumer goods are end products & have no future productive
use. For example, a watch
A PPC for an economy demonstrating the use of its resources to produce capital
or consumer goods

Diagram Explanation

 The use of PPC to depict the maximum productive potential of an

economy
o The curve demonstrates the possible combinations of the maximum
output this economy can produce using all of its resources (factors
of production)
o At A, its resources are used to produce only consumer goods (300)
o At B, its resources are used to produce only capital goods (200)
o Points C & D both represent full (efficient) use of an economy's
resources as these points fall on the curve. At C, 150 capital goods
and 120 consumer goods are produced

 The use of PPC to depict opportunity cost

 o To produce one more unit of capital goods, this economy must give
up production of some units of consumer goods (limited resources)
o If this economy moves from point C (120, 150) to D (225, 100), the
opportunity cost of producing an additional 105 units of consumer
goods is 50 capital goods
o A movement in the PPC occurs when there is any change in the
allocation of existing resources within an economy such as the
movement from point C to D

 The use of PPC to depict efficiency, inefficiency, attainable and

unattainable production
o Producing at any point on the curve represents productive efficiency
o Any point inside the curve represents inefficiency (point E)
o Using the current level of resources available, attainable production
is any point on or inside the curve and any point outside the curve is
unattainable (point F)

Shifts in a PPC
 As opposed to a movement along the PPC described above, the entire PPC
of an economy can shift inwards or outwards
Outward shifts of a PPC show economic growth & inward shifts show economic
decline

Diagram Explanation

 Economic growth occurs when there is an increase in the productive

potential of an economy
o This is demonstrated by an outward shift of the entire curve. More
consumer goods and more capital goods can now be produced using
all of the available resources
o This shift is caused by an increase in the quality or quantity of the
available factors of production
 One example of how the quality of a factor of production can be
improved is through the impact of training and education on
labour. An educated workforce is a more productive workforce
and the production possibilities increase
  One example of how the quantity of a factor of production can
be increased is through a change in migration policies. If an
economy allows more foreign workers to work productively
in the economy, then the production possibilities increase

 Economic decline occurs when there is any impact on an economy that

reduces the quantity or quality of the available factors of production
o One example of how this may happen is to consider how the Japanese
tsunami of 2011 devastated the production possibilities of Japan for
many years. It shifted their PPC inwards and resulted in economic
decline