The nature of the basic economic problem
Revising effectively: Learn the definitions first, then make sure you can explain each cause-and-effect link and apply it to a consumer, worker, firm or government.
Key definitions
- Scarcity - finite resources are insufficient to satisfy infinite wants.
- Needs - goods and services that are necessary for life.
- Wants - goods and services people would like to have. Wants are not all essential for survival.
Why scarcity is the basic economic problem
The problem of scarcity means that it is impossible to produce every good and service that people want.
Scarcity forces choices to be made. When a scarce resource is used for one purpose, it cannot be used for every other purpose at the same time. Economics studies how these choices are made and how resources are allocated.
Core chain: finite resources + infinite wants -> scarcity -> choices must be made
The economic problem in different contexts
| Decision-maker | Why scarcity creates a choice | Example |
|---|---|---|
| Consumers | Income and time are limited, so consumers cannot purchase everything they want. | A student may choose a laptop instead of a holiday. |
| Workers | Workers have limited time, skills and qualifications. They must choose how much to work and which occupation or training to pursue. | Going to university may mean giving up income from a full-time job. |
| Producers / firms | Firms have limited finance, workers and materials, so they must choose which products to make and how to make them. | A bakery may use its budget to buy an oven instead of opening another shop. |
| Governments | Tax revenue and public resources are limited, while society has many demands. | Funding a railway may leave less funding for hospitals or schools. |
Resource allocation decisions
Every economy must decide how its scarce resources will be distributed. This creates three questions:
- What to produce? Which goods and services should be made, and in what quantities?
- How to produce? Which workers, machinery, materials and production methods should be used?
- Who to produce for? Who will receive the goods and services that are produced?
An efficient allocation creates the greatest possible benefit and avoids unnecessary waste. However, people may disagree about which use creates the greatest benefit.
Economic goods and free goods
| Economic goods | Free goods |
|---|---|
| Scarce relative to the demand for them. | Abundant relative to the demand for them (price of zero). |
| Resources are required to produce or obtain them. | No scarce resources are required |
| Because their supply is limited, choices must be made about who receives them and how they are used. | They are sufficiently abundant that using them does not reduce the amount available to others (aka non-rivalrous) |
| Examples: food, housing, electricity and bottled water. | Examples: sunlight and ordinary air under normal conditions. |
Exam trap: A good does not become a free good just because it is free. A free sample is still an economic good because scarce resources were used to produce it.
Whether something is a free good depends on context. Clean air may be freely available in one place but scarce in a polluted environment.