The Basic Economic Problem Choices and the allocation of resources Section 1

Learning Objectives? The problem of unlimited wants and finite resources. The distinction between renewable and non-renewable resources. The use of production possibility frontiers to depict opportunity cost, Economic growth and the efficient allocation of resources. The use of marginal analysis in depicting opportunity cost. The distinction between movements along and shifts in production possibility frontiers, and their possible causes

The basic economic problem Resources are scarce and we have limitless wants There are some who think that oil will run out in 40 years Oil is a scarce resource Oil isn’t the only scarce resource – other commodities like aluminium, copper, lead, tin, zinc and timber might also get used up if we continue to consume them at the same rate as we are doing today How do we manage to make these last? This is the central problem that we study in economics The economic problem: there are limited resources and unlimited wants Watch first few minutes of this video https://www.youtube.com/watch?v=WiNtrOS88rs

These are also called factors of production When we talk about resources we are talking about land, labour, capital and enterprise These are also called factors of production Land – the land itself, sea, forests, soil, minerals such as coal and oil – anything that is a natural resource Labour – the people that work to make goods and services Capital – the man made resources that help to produce goods and services such as factories, equipment, computers etc Enterprise – people that manage and control the firms that make the goods and services Factors of Production – Land, labour, capital and enterprise

Renewable vs Non-Renewable Non-renewable resources such as coal, oil, gold and copper are all land resources that once used will never be replaced Renewable resources are also land resources but they can be replaced e.g. fish stocks, forests or water

Production Key Definition! Using inputs (resources) to make outputs (goods and services) to satisfy the needs and wants of consumers

The satisfaction of human wants There is a difference between needs and wants Needs are those things that people need to have to survive e.g. water Wants are things that people can do without but make life more enjoyable Needs– any resource that is not scarce e.g. air Complete Activity 1.2 P7

Consumption Key Definition! When we eat we are consuming food When we watch television we are consuming electricity The people who buy goods and services to satisfy their wants are known as consumers and their spending is called consumption expenditure Some people can produce a number of their own goods and services (e.g. grow veg in the garden) For the rest they must engage in trade or exchange To do this they go to work to earn money They exchange the money for the goods and services Consumption - Using up goods and services (products) to satisfy consumers’ needs and wants

Economists group different products into four categories Goods and Services Economists group different products into four categories Consumer goods and services – any good that satisfies consumer wants Consumer durables – last a long time like a car Non durables – must be used quickly like food and drink Capital goods Man made resources that help produce other goods and services Public goods and merit goods Public goods are provided by government because everyone benefits from them and no private company would produce them e.g. defence, street lighting etc Merit goods – government provides because private companies don’t provide enough – e.g. healthcare or education

The basic economic problem Back to……… The basic economic problem Human wants are unlimited but resources are scarce

So, we all have to make choices There is a limited amount of resources such as raw materials, machines, factories and skilled workers. But there are a number of different ways in which they can be used. CHOICE CHOICE Resource allocation therefore involves deciding how best to use scarce resources to satisfy as many needs and wants as possible

Opportunity Choice Key Definition! If you have a limited amount of money you have to make a choice as to what you spend it on Government has to do the same The cost of something is what we have to give up to get it (the next best alternative) Opportunity cost – the cost of the next best alternative foregone Complete activity 1.6 P12 $100bn $100 Food? Entertainment? Clothing? Defence? Health care? Roads?

Production possibility curves Opportunity cost – the cost of the next best alternative foregone Because resources are scarce and have alternative uses, a decision to devote more resources to producing one product means fewer resources are available to produce other goods We can use a PPC to illustrate this This firm can make 100 cars per week or 120 trucks per week Combinations are plotted on the PPC

Production possibility curves Opportunity cost – the cost of the next best alternative foregone What is the opportunity cost of making 120 trucks? For the firm to make 120 trucks it has to give up 100 cars What is the opportunity cost of making 100 cars? It has to give up 120 trucks so that is the opportunity cost If this firm is producing at point A and it wants to produce 18 more trucks what is the opportunity cost? 10 cars If the firm is at point B and wants to produce 10 more cars what is the opportunity cost? 18 trucks

Production possibility curves A PPC of an economy shows the maximum amount of goods an economy can make using all of its factors of production What is the opportunity cost of producing 15 more tonnes of consumer goods? What is the alternative? The capital goods To make more consumer goods you have to give up capital goods To go from 50 to 65 consumer goods you have to go from 60 to 50 capital goods You are giving up 10 The opportunity cost of making 15 more tonnes of consumer goods is 10 tonnes of capital goods Opportunity cost – the cost of the next best alternative foregone An economy producing consumer goods and capital goods

Production possibility curves Production possibility curves (PPCs) show the maximum combined output of two or more products a firm or an entire economy can produce with its available resources Resources are being used efficiently if they are producing their maximum output But, because resources are limited, producing more of one product means producing less of another PPCs are therefore a useful way of showing the opportunity cost of producing more of one product in terms of how much of another must be given up

The concept of the margin Margin = a point of possible change At the point C the economy could produce more manufactured goods but it would need to give up non-manufactured goods The marginal cost of producing 5 more units of manufactured goods would be 10 fewer units of non-manufactured goods (shown by the movement from C to D)

Economic growth At point F resources are not being efficiently as possibly A movement from point F to a point on the PPB would not represent economic growth – just a better use of resources Economic growth can only be represented using a shift of the PPB like in the diagram on the right Growth can happen for two reasons An increase in the quality of factors of production An increase in the quantity of factors of production