Chapter 3:
The Economic Problem – The
Problem of Scarcity
Limited resources < Unlimited Wants
The Resources of the Economy
 Resources or Factors of Production are the
various things that can be used to produce goods
and services
 Land – resources given to us by nature eg.
Minerals, fish, oxygen, rivers, lakes, sunlight
 Labour – physical and mental efforts that people
contribute to production
 Capital – any manufactured good that is used for
the production of other goods and services
 Entrepreneurship – includes managerial and
decision making skills; the bringing together of the
factors of production to organize them into
production
RESOURCES
Factors
of Production
Land
Labour
Capital
Characteristics Compensation
All natural
Rent
resources
Human Resources Wages and salaries
Manufactured
Resources
Entrepreneurship Organization and
Decision Making
skills
Interest and
dividends
Profits
SCARCITY, CHOICE and
OPPORTUNITY COST
•
Scarcity of resources requires a
choice between wants
 Opportunity cost refers to the
alternative that is sacrificed when a
choice is made
Example: If a city decides to build a school
instead of adding a wing to a hospital, then the
opportunity cost of the school is the additional
hospital facilities that the city would have had
instead
PRODUCTION POSSIBILITIES
 the PPC (production possibilities curve) is an
economic model that illustrates the economic
problem of scarcity
 Assume that an economy devotes all of its
resources to the production of only two goods,
houses and automobiles
 Several possible combinations of houses and
automobiles is possible, as illustrated in the
production possibilities schedule
Production Possibilities Schedule
Possibilities
Number of Houses
1
2
3
4
5
6
7
8
9
0
100, 000
200, 000
300, 000
400, 000
500, 000
600, 000
700, 000
800, 000
Number of
Automobiles
8, 000, 000
7, 000, 000
6, 000, 000
5, 000, 000
4, 000, 000
3, 000, 000
2, 000, 000
1, 000, 000
0
 If the economy uses all of its resources to
produce automobiles, it can produce a
maximum of 8, 000, 000 automobiles and no
houses (possibility 1)
 If it uses all of its resources to produce houses,
then it can produce a maximum of 8, 000,
000 houses and no automobiles (possibility 9)
 Between these two extreme cases are many
possibilities
 Note that for every 100, 000 houses produced,
the economy sacrifices/does not produce 1
000, 000 automobiles.
 Thus the opportunity cost of 100, 000 houses
is 1, 000, 000 automobiles
 That is, in order to produce one house the
economy must sacrifice 10 automobiles
 In this example the opportunity cost remains
constant throughout
Houses
(00, 000)
Automobiles
(000, 000)
The Production Possibilities Model
The production possibilities model is based
on three assumptions:
1. an economy makes only two products
2. resources and technology are fixed
3. all resources are employed to their
fullest capacity
The Production Possibilities
Curve
•
The production possibilities curve shows
a range of possible output combinations
for an economy.
–It highlights the scarcity of resources.
–It has a concave shape, which reflects
the law of increasing opportunity
costs.
The Production Possibilities
Curve
Production Possibilities Curve
Production Possibilities
Schedule
a
1000
b
f
Hamburgers Computers
Hamburgers
900
point
on graph
1000
0
a
900
1
b
600
2
c
unattainable
c
600
e
inefficient
d
0
3
d
0
1
2
Computers
.
3
The Law of Increasing Costs
Hamburgers
1000
Opportunity Computers point
Cost of
on graph
Computers
0
a
100
900
1
b
2
c
Production Possibilities Curve
a
1000
As the quantity
of computers
rises, so does their
opportunity cost.
b
900
Hamburgers
Production Possibilities Schedule
600
c
300
600
600
0
d
3
d
0
1
2
Computers
3
Shifts in Production Possibilities
Production Possibilities Curve
With more
computers, the
curve shifts out
in the next
period.
Hamburgers
1000
0
3
Computers
.
The Basic Economic Questions
There are three basic questions
any society must answer:
1.
what to produce
2.
how to produce
3.
for whom to produce
.
What to Produce?
 What goods/services should our society
produce & how much?
 What is worth producing and what is not?
 What must we give up to produce the
chosen goods/services?
How to Produce?
 Who will produce, with what resources and
method?
 How can we be most efficient?
 Technology vs. Manual labour?
For Whom to Produce?
 How will output be shared among the
members of our society?
 Who will get what?
 How will we decide on the “Division of the
Economic Pie” ?
• How a society answers the above
questions will dictate the type of
Economic System that will operate.
• An economic system is a set of laws,
institutions and common practices that
help a nation define how to use its scarce
resources to satisfy as many of its
people’s needs and wants as possible.
The Traditional Economy

The practices of the past determine the answers to the three economic
questions.

All goods/services produced today are the same as was produced in the
past.

They are produced in the same manner and skills, etc. are passed on
through family for generations.

This type of economic system is typical for less advanced societies where
just meeting the basic needs of survival is the most important task of the
day.

Currencies are rarely used here and barter is common.

Ex include: Bedouin/Bushmen/Mongols/Lapps/Masai/Waura/Mbuti/Senoi
The Command Economy
(North Korea )

All production decisions are made by a small group of political leaders who in effect control the
country in question. i.e. Central Planning

These leaders are usually high ranking members of the military.

The central planning group answers all economic questions based on what is in the “best interest”
of the state.

All productive resources are owned by the state and “efficiently” allocated by the central planners.

The only obligation an individual has in this type of society is to serve and be loyal to the state.

In return, central planners take care of individual needs like food, shelter, medicine, education, etc.

More loyalty to the state is rewarded and lack of loyalty is punished.

Central planners determine who will work where, what equipment will be used, and how much
each worker will be paid.

Workers only really need to buy food, clothing and shelter as everything else is provided free of
charge by the state.

This means there is more emphasis on producing capital goods rather than consumer goods.
The Market Economy

•
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•
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•
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•

•
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•
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•
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•

Economic questions are decided upon based on the interaction between buyers and sellers
in free markets where resources are privately owned. i.e. free or private enterprise
What will be produced is determined by demand for the particular product or service in
question.
Businesses will only produce what is in demand, otherwise they will be forced to close.
How goods are produced is dictated by the producers quest for profits.
Producers will try to be as efficient as possible to cut costs. This will, in turn, increase
profits.
A benefit of this action is the competition that will result in lower prices for the consumer.
For whom to produce depends solely on consumer incomes. People with higher incomes
will be able to afford the most and those with low incomes the least.
The basic elements of a market economy are private property, freedom of enterprise, profit
maximization and competition.
The government’s only involvement with the economy is to provide law and order and to
assist with economic development.
The Mixed Market Economy
(Canada, Sweden, UK)

Since very few pure economic systems exist today, the rest combine some aspects from each of
the pure systems.

The economy will have both private enterprise and state-run enterprise.

Basically a mixed system allows for more government involvement in the economy, usually to
provide some form of social welfare for its citizens.

Some of the more positive government run and/or controlled items are:
o
o
o
o
o
o
o
Crown Land
Universal Health Care
Employment Insurance
Social Security for seniors
Welfare
Media and Arts (CBC)
Education
 There are also “negative” aspects of more government:
•
o High Taxes
o Underground Economy
o Abuse of the System
Understanding Political
Economies
• A democracy is a political system whereby a
freely elected government represents (for a
set term) the majority of citizens. There are
usually many parties with a variety of political
views.
• A dictatorship is a political system whereby
a single person or party has absolute control
over an entire nation (usually via the military).
There are no free elections allowed.
Communism
(China, Cuba, North Korea, Vietnam)
 A political model based on the theories of Karl Marx,
Friedrich Engels, and Vladimir Lenin
• The government owns all means of production and
wealth.
 There is no private property or free enterprise.
 Individuals produce according to their ability and
consume according to their needs.
 Central government planning is used.
 The theory was that everyone would share and the
society would prosper with no class system emerging.
 The reality was a corrupt centrally controlled economy
where the military ruled and communist party members
were treated favourably.
Socialism
(Norway, Denmark, Sweden, Finland)
 Based on public ownership/control of the
factors of production.
 Democratic and peaceful methods are used
to accomplish this.
 Try to promote a fair and equal distribution of
available goods/services via democratic
decision-making process.
 Co-operation and worker solidarity are
encouraged.
Capitalism
(Hong Kong, USA, Singapore)
 Based on the theories of Adam Smith (1723-1790)
 Requires a democratically elected government to
maintain order and free/fair competition.
 Private ownership is encouraged.
 Producers are motivated to maximize profit
(minimize loss) by becoming more effective and
efficient than the competition.
 Most modern industrial countries use elements of
this system mixed with elements of socialism to
produce “welfare capitalism”
Fascism (Nazi Germany)
 Occupies the far right of the political spectrum.
 Usually combines a free-market economy with a
strict form of government.
 Force is used as a means of political/economic
control.
 Citizens are free to own property and make profits
as long as they do not oppose the party in power.
Economic Systems
•
There are three systems to choose from:
– Traditional economies focus on non-economic
concerns and have tight social constraints.
– Market economies are consumer-centered and
innovative but create inequality and instability.
– Command economies equalize incomes but often
have a lack of freedom.
The Range of Economic Systems
•
Most countries have mixed economies.
– Modern mixed economies include both private
and public sectors.
– Traditional mixed economies combine traditional
sectors with private and/or public sectors.
The Range of Economic Systems (b)
Economic Goals
•
There are seven major economic goals:
–
–
–
–
–
–
–
economic efficiency
income equity
price stability
full employment
viable balance of payments
economic growth
environmental sustainability
Complementary and Conflicting
Economic Goals
•
Economic goals may be complementary.
– An example is the relationship between full employment and
economic growth.
•
Economic goals may be conflicting.
– An example is the relationship between price
stability and full employment.
The Founder of Modern Economics
Adam Smith:
– explained how the division of labour increases production
– argued that self interest is transformed by the invisible hand
of competition so that it creates significant economic
benefits
– stressed the principle of laissez faire, which means that
governments should not intervene in economic activity