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THE BASIC ECONOMIC PROBLEM
Economics
A social science that studies human behaviour between limited resources and
unlimited needs and wants.
The Basic Economic Problem
There are limited resources but unlimited needs and wants to be fulfilled with those
resources.
Resources
 Materials and efforts used to produce Goods and Services.
 e.g, raw material , labour , machinery
i)
Scarce Resources / Limited Goods
 Scarce means limited. The Scarce Resources will be finished after consumption.
 e.g oil, coal, gas, wood etc.
ii)
Free Goods
 Goods that are unlimited in supply. These will never finish, whatever quantity is
consumed.
 e.g, air, sea water, sunlight
Economic Goods
Goods that are scarce in supply and have an opportunity cost.
Following is the more detail:
 Resources: are the inputs required for the production of goods and services.
 Scarcity: a lack of something (in this context, resources).
The fundamental economic problem is that there is a scarcity of resources to
satisfy all human wants and needs. There are finite resources and unlimited
wants. This is applicable to consumers, producers, workers and the government,
in how they manage their resources.
Economic goods are those which are scarce in supply and so can only be
produced with an economic cost and/or consumed with a price. In other words,
an economic good is a good with an opportunity cost. All the goods we buy are
economic goods, from bottled water to clothes.
Free goods, on the other hand, are those which are abundant in supply, usually
referring to natural sources such as air and sunlight.
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FACTORS OF PRODUCTION (Resources)
Materials and efforts used to produce goods and services.
There are four factors of production:
1- Land: All the natural resources existing on earth. e.g, earth surface, crops, oil,
minerals, livestock etc.
2- Labour: Mental and Physical human efforts used to produce goods and services
3- Capital: Man made resources used to produce goods and services. E.g,
machines, equipment etc.
4- Entrepreneur: The person takes the risk of combining the factors of production.
His risk taking ability is known as enterprise.
Following is the more detail:
 Resources: are the inputs required for the production of goods and services.
 Scarcity: a lack of something (in this context, resources).
The fundamental economic problem is that there is a scarcity of resources to
satisfy all human wants and needs. There are finite resources and unlimited
wants. This is applicable to consumers, producers, workers and the government,
in how they manage their resources.
Economic goods are those which are scarce in supply and so can only be
produced with an economic cost and/or consumed with a price. In other words,
an economic good is a good with an opportunity cost. All the goods we buy are
economic goods, from bottled water to clothes.
Free goods, on the other hand, are those which are abundant in supply, usually
referring to natural sources such as air and sunlight.
FACTORS OF PRODUCTION (Resources)
Materials and efforts used to produce goods and services.
There are four factors of production:
5- Land: All the natural resources existing on earth. e.g, earth surface, crops, oil,
minerals, livestock etc.
6- Labour: Mental and Physical human efforts used to produce goods and services
7- Capital: Man made resources used to produce goods and services. E.g,
machines, equipment etc.
8- Entrepreneur: The person takes the risk of combining the factors of production.
His risk taking ability is known as enterprise.
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Following is the more detail:
Resources are also called ‘factors of production’. They are:

Land: all natural resources in an economy. This includes the surface of the earth,
lakes, rivers, forests, mineral deposits, climate etc.
 The reward for land is the rent it receives.
 Since, the amount of land in existence stays the same, its supply is said to be
fixed. But in relation to a country or business, when it takes over or expands to a
new area, you can say that the supply of land has increased, but the supply is not
depended on its price, i.e. rent.
 The quality of land depends upon the soil type, fertility, weather and so on.
 Since land can’t be moved around, it is geographically immobile but since it can
be used for a variety of economic activities it is occupationally mobile.

Labour: all the human resources available in an economy. That is, the mental and
physical efforts and skills of workers/labourers.
 The reward for work is wages/salaries.
 The supply of labour depends upon the number of workers available (which is in
turn influenced by population size, no. of years of schooling, retirement age, age
structure of the population, attitude towards women working etc.) and the number of
hours they work (which is influenced by number of hours to work in a single
day/week, number of holidays, length of sick leaves, maternity/paternity leaves,
whether the job is part-time or full-time etc.).
 The quality of labour will depend upon the skills, education and qualification of
labour.
 Labour mobility can depend up on various factors. Labour can achieve high
occupational mobility (ability to change jobs) if they have the right skills and
qualifications. It can achieve geographical mobility (ability to move to a place for a
job) depending on transport facilities and costs, housing facilities and costs, family
and personal priorities, regional or national laws and regulations on travel and work
etc.
Capital: all the man-made resources available in an economy. All man-made goods
(which help to produce other goods – capital goods) from a simple spade to a complex
car assembly plant are included in this. Capital is usually denoted in monetary terms as
the total value of all the capital goods needed in production.
 The reward for capital is the interest it receives.
 The supply of capital depends upon the demand for goods and services, how well
businesses are doing, and savings in the economy (since capital for investment is
financed by loans from banks which are sourced from savings).
 The quality of capital depends on how many good quality products can be produced
using the given capital. For example, the capital is said to be of much more quality in
a car manufacturing plant that uses mechanisation and technology to produce cars
rather than one in which manual labour does the work.

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Capital mobility can depend upon the nature and use of the capital. For example,
an office building is geographically immobile but occupationally mobile. On the other
hand, a pen is geographically and occupationally mobile.
Enterprise: the ability to take risks and run a business venture or a firm is called
enterprise. A person who has enterprise is called an entrepreneur. In short, they are the
people who start a business. Entrepreneurs organize all the other factors of production
and take the risks and decisions necessary to make a firm run successfully.
 The reward to enterprise is the profit generated from the business.
 The supply of enterprise is dependent on entrepreneurial skills (risk-taking,
innovation, effective communication etc.), education, corporate taxes (if taxes on
profits are too high, nobody will want to start a business), regulations in doing
business and so on.
 The quality of enterprise will depend on how well it is able to satisfy and expand
demand in the economy in cost-effective and innovative ways.
 Enterprise is usually highly mobile, both geographically and occupationally.
Rewards/ Incomes of Factors of Production:
Payments made to the factors of production for using them.
•
LAND- RENT
•
LABOUR - WAGE
•
CAPITAL - INTEREST
•
ENTREPRENEUR-PROFIT
Need
Essentials for human survival. There are five basic human needs:
1- Food
2- Water
3- Shelter
4- Clothing
5- Air
Wants
Things that are good or pleasant to have, make human life easier and
comfortable to live but not essential for survival. e.g, car, phone, laptop etc.
Goods
Tangible products, that exist physically, used to satisfy human needs and wants.
e.g, Table, Book, Truck etc.
Services
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Intangible products, that do not exist physically, used to satisfy human needs and
wants. e.g, Teaching, banking, insurance etc.
Product:
A good or service used to satisfy need or want.
Production
A process or activity that is used to convert inputs into outputs.
Inputs-----Factors of Production
Outputs---Products
Producer: The person who combines the factors of production to produce products
Cost of Production: Amount of money spent by the producer to produce goods and
services.
Consumption
The using up of a good or service to satisfy one’s needs and wants.
Consumer: The person who consumes the factors of production to satisfy his needs
and wants.
Consumption Expenditure: The amount of money spent by the consumer to satisfy
his need or want.
Utility
The satisfaction derived by a consumer to satisfy his need or want.
Opportunity Cost:
It is the next best alternative forgone.
Consumer: A girl has $1000. She can either buy a smart phone or a laptop. If she
buys the laptop then, the phone is her opportunity cost.
Producer: A business has $100,000. It can either spend on buying new equipment or
Research and development. If it spends it on the new equipment, then, Research and
development is the opportunity cost.
Govt: A business has $10, 00,000. It can either spend on building a new road or a
building a university.. If it spends it on the new University, then, Road is the opportunity
cost.
Mobility of Factors of Production
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The ease with which factors of production can be moved from one productive activity to
another without incurring significant losses.
i)
Occupational Mobility / Task Mobility
It refers to the ability to move factors between different productive tasks.
ii)
Geographical Mobility
It refers to the ability to move factors of production to different locations.
Causes of Mobility OR Immobility of the Factors of Production
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Public Sector:
It consists of all the organizations that are owned, controlled and financed by the govt.
Their aim is to serve the general public.
e.g, Jinnah Hospital, Punjab University, WAPDA
Private Sector:
It consists of all the organizations that are owned, controlled and financed by the private
individuals.
Their aim is profit maximization.
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Public Goods
A public good is a good that is provided by the govt. to its public, free of cost. It is is
both non-excludable and non-rivalrous. For such goods, users cannot be barred from
accessing or using them for failing to pay for them. Also, use by one person neither
prevents access of other people nor does it reduce availability to others. Therefore, the
good can be used simultaneously by more than one person.
Examples of public goods include roads, street lights, law enforcement, national
defense, and the rule of law.
Merit Goods
Merit goods are those goods and services that the government feels that people ought
to have even they cannot afford to pay for them. These will be under-consumed, and
which ought to be subsidized or provided free at the point of use so that consumption
does not depend primarily on the ability to pay for the good or service. E.g, Education,
Health
MICROECONOMICS
Microeconomics is the study of individual markets. For example: studying the effect of
a price change on the demand for a good. Microeconomic decision makers are
producers and consumers (who directly operate in markets)
It refers to the body of economic principles and concepts that explains the behaviour of
individuals and firms in different situations. The issues covered in microeconomics can
include scarcity and opportunity costs, pricing of goods and services, utility, budget line
and indifference curves, costs, revenues and profits of firms.
MACROECONOMICS
Macroeconomics is the study of an entire economy, as a whole. Examples include
studying the total size of the economy or the unemployment rate, among other things.
Macroeconomic decisions are made by the government of the particular economy – a
town, state or country.
It refers to the economic issues that relate to the whole economy. These issues can
include economic growth, unemployment, inflation, national income, and living
standards.
POSITIVE STATEMENT
It is based on empirical or actual evidence.  Statements about economics that can be
proven to be true or false.
 These can be supported or refuted by evidence.
 For example, following is a positive statement: ‘the inflation rate in 2009 was 2.5%.’
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 Statements about the future can also be positive statements. For example, ‘The
service sector will grow by 30% in size over the next five years.’ So Statement is
capable of being proved or disproved even though economists may have to wait for five
years to know whether it was actually true or false.
NORMATIVE STATEMENTS
It involves value judgments and are ones that are subjective about what should happen.
These statements cannot be supported or refuted.
 They are opinions about how economies and markets should work.
 For example, the following statements are normative:
‘The government should cut fuel tax to reduce the rate of inflation.’ O
‘Public sector workers should reduce their demands for higher wages.’
 These are often drawn from the economist’s personal views, political beliefs and
ethics.
 Normative statements tend to contain words like ‘should’ and ‘ought’. Although
sometimes positive statements also contain these words
Resource allocation: the way in which economies decide what goods and services to
provide, how to produce them and who to produce them for.
These questions1. what to produce
2. how to produce
3. for whom to produce
are termed ‘the basic economic questions’. In short, resource allocation is the
way in which economies solve the three basic economics questions.
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