The basic economic problem Scarcity, Factors of production & Opportunity cost Lesson objective: Students should be able to: • Define the nature of the economic problem (finite resources and unlimited wants) • Define opportunity cost and analyse particular circumstances to illustrate this concept. • Evaluate the implications of particular courses of action in terms of their opportunity cost. BASIC ECONOMIC PROBLEM • The basic economic problem is scarcity. This means that there are finite/limited resources available to satisfy our unlimited wants. As a result, we have to make a choice. • Due to scarcity, consumers must therefore, choose what goods and services they will consume and producers must choose what goods and services to produce and who to produce them for. • Choosing how best to use resources is the problem of resource allocation. ECONOMIC GOODS VS FREE GOODS • Free goods: Any resource that is not scarce and cannot be traded is called a free good. Example: the air that we breathe seems to be without limit and so it is considered to be a free good. • Economic goods: These are goods which are scarce, commands a price and is capable of giving satisfaction. FACTORS OF PRODUCTION • Factors of production are scarce resources used in the production of goods and services to satisfy our needs and wants. • The factors of production are classified into: LAND, LABOUR, CAPITAL & ENTERPRISE LAND • These refers to all natural resources used in the production of goods and services. • Example: water, coal, natural gases, mineral reources (like copper, gold, silver etc) • The reward for land is rent LABOUR • This refers to the mental and physical effort used up in the production of goods and services. This is also referred to as human resource. • Examples: Teacher, lawyer, doctor, carpenter, plumber etc. • The reward for labor is wage/salary CAPITAL • This consists of man-made resources used in the production of other goods and services. • Examples: tools, machinery, office and factory buildings. • The reward for capital is interest. Enterprise • Enterprise is the risk-taking ability to combine the other factors of production in order to produce goods and services. • People who possess this risk-taking ability are called entrepreneurs. They are willing to take the risk to start and run a firm. • Example: CEO • The reward for enterprise is Profit. OPPORTUNITY COST • In economics, the true cost of something is what we have to give up to get it. This is known as the opportunity cost. • Opportunity cost can be defined as the next best alternative foregone when we make a choice. • Opportunity cost arises not only when we need to buy things but also when we choose how to allocate resources to the production of different goods and services. Importance of opportunity cost • To the individual: The concept of opportunity cost helps individuals or consumers to decide how to spend or allocate their available scarce resources efficiently. • To the firms: The concept of opportunity cost will help firms to allocate their resources to the production of those items or goods that will give them maximum profit. Also, a firm might have to choose between using machines (Capital intensive) or labour (labour intensive) in its production process. • To the government: The concept of opportunity cost will help the government to decide on the best way to allocate its scarce resources. The government generates revenue from different sources (example: income tax, import duties etc.) and this revenue is limited. So the government has to decide on how to allocate its resources to provide goods and services for the people. Also, a country has limited resources and so if more resources are devoted to one area, less can be devoted to other areas of the economy. Examples of opportunity cost • A government decides to raise an additional $10 billion in taxes to fund the building of new motorways. The roads will improve journey times for many motorists. However, the money could have been used to provide new schools instead. Taxpayers will also have to give up more of their income to pay the increased taxes. • A group of business owners choose to invest $5million in building a new hotel. They could have invested the money in their car hire business instead but thought the hotel venture will earn them more profit instead. The opportunity cost of the decision to build a new hotel is the car hire business which they had to give up. • Choosing between alternative uses of scarce resources therefore involves conflicts of interest. People cannot always get what they want and some will be dissatisfied or adversely affected by the choices made by others. • In the example above, the governments decision to invest $10billion in the construction of new motorways was at the expense of building new schools. There will be a conflict of interest because motorways will benefit motorists but will fail to satisfy the wants of students and their families for improved educational facilities. The same decision will also conflict with the wants of taxpayers to pay lower taxes. • A conflict of interest (COI) is a situation in which a person or organization is involved in multiple interests, financial or otherwise, and serving one interest could involve working against another.
