Chapter 1: The Economic Problem
Key Terms
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Free goods: goods which is unlimited in supply and have zero opportunity cost (eg. sunshine
and air)
Economic good: a goods which is limited in supply ∴ has an opportunity cost
Needs: Basic essentials that are required for survival. Needs are limited (eg. food, shelter,
clothing)
Wants: desires to own things. Wants are unlimited (eg. designer clothes, cars etc.)
Basic Economic Problem: how to satisfy unlimited wants with limited resources
o Solving Economic Problem: make a choice which leads to opportunity cost
o Scarcity → choice → opportunity cost
Production Possibility Frontier / Curve (PPF): Shows the maximum combination of output a
nation can make with given set of fixed inputs / resources.
Productive Efficiency: Full employment of resources
Factors of Production (FOPs): scarce resources needed in the production of goods and
services to satisfy human needs and wants
o Land: is a natural resource (eg. trees, minerals, fish, oil, water, gold)
▪ Reward for Land is Rent
o Labour: is a human resource that includes physical effort or mental effort. Needed in
the production of goods and services to satisfy needs and wants
▪ Reward for Labour is wages
o Capital: is a man-made resource (eg. roads)
▪ Capital Good: a good which can "further" another good. Firms buy capital
goods (eg. finance (money needed to start a business), machinery)
▪ Reward for Capital is interest
o Enterprise / Entrepreneur: a human resource that has "risk taking ability" that
organises the other factors of production into a production unit to produce a
good/service.
▪ Reward for Enterprise is Profit
Study Notes
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The basic economic problem is that resources are scarce. In economics, these resources are
called the factors of production.
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Scarcity
o Definition: Scarcity occurs because resources are finite (limited) but human wants
are infinite (unlimited).
o Examples of resources: oil, fertile soil, fish, water, labour, capital, and land.
o Examples of wants: holidays, bigger houses, new clothes, cars.
o Key Point: Scarcity forces societies to make choices about how to use resources.
To solve the Basic Economic Problem, three key questions have to be answered.
o What to produce?
▪ A country must decide which goods and services should be made.
▪ Example: more schools and hospitals, or more weapons and military
equipment?
o How to produce?
▪ Which methods should be used?
▪ Example: Use more labour (workers) or more capital (machines)?
o For whom to produce?
▪ How should goods and services be distributed among people?
▪ Example: Should everyone get an equal share, or should distribution depend
on income and wealth?
Opportunity Cost
o Definition: The cost of the next best alternative given up when a choice is made.
o Why it occurs: Because resources are scarce, choices must be made. Each choice
involves giving up something else.
o Examples:
o An individual choosing to spend £20 on a cinema ticket instead of a book.
Opportunity cost = the book.
o A government choosing to build a new hospital instead of a motorway. Opportunity
cost = motorway.
Production Possibility Curves (PPCs) / Production Possibility Frontier
o Definition: An economic model that shows the maximum possible combinations of
two goods/services an economy can produce if all resources are used efficiently.
o Key points on the PPC:
▪ PPC diagrams show capital goods and consumer goods on the axes
▪ capital goods – those purchased by firms and used to produce other goods
such as factories, machinery, tools and equipment.
▪ consumer goods – those purchased by households such as food,
confectionery, cars, tablets and furniture.
▪ Points on the curve = efficient use of resources.
▪ Points inside the curve = inefficient use (unemployment or under-used
resources).
▪ Points outside the curve = not possible with current resources.
▪ Opportunity cost on PPC: Moving along the curve means producing more of
one good but less of another. The amount lost is the opportunity cost.
▪ Example: If moving from 14m consumer goods + 4m capital goods → to 8m
consumer goods + 7m capital goods, the opportunity cost = 6m consumer
goods lost.
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Causes of Positive Growth (PPC shifts outwards):
o New technology: More efficient machines, IT, robotics.
o Improved efficiency: Better production methods (e.g. lean production, Kaizen).
o Education and training: Skilled workers increase productivity.
o New resources: Discovery of oil, gas, minerals, or more fertile land.
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Causes of Negative Growth (PPC shifts inwards):
o Resource depletion: Running out of oil, coal, or minerals.
o Natural disasters/war: Destroy factories, homes, and reduce productive capacity.
o Loss of workers: Skilled workers migrate to other countries.
o Agricultural problems: Droughts or floods reduce food production.
Notes written by Roopali