THE BASIC ECONOMIC PROBLEM
The basic economic problem is scarcity. Scarcity arises because human wants for goods and services are infinite but the resources required to produce them are finite.
THE BASIC ECONOMIC PROBLEM
Resources are scarce but human wants are unlimited.
The central purpose of economic activity is the production of goods and services with these limited resources in order to try and satisfy as many of the unlimited needs and wants as possible. This is done in order to try and improve or maximise economic welfare. The level of prosperity and quality of living standards in an economy.
THE PROBLEM OF SCARCITY – Not all wants can be satisfied, therefore choices have to be made over which wants to satisfy, or how the scarce resources are allocated amongst competing wants. This leads to conflict and economics tries to relieve conflict. The problem of scarcity means that choices have to be made and therefore an allocative mechanism is needed to answer the basic economic questions of: • • •
What to produce? How to produce? For whom to produce? The method by which resources are allocated between alternative uses.
THE NATURE AND PURPOSE OF ECONOMIC ACTIVITY
Economic welfare is a concept which isn’t easily defined; it refers to how well people within society are doing. Economic welfare is usually measured in terms of real income, real GDP. An increase in real output and real incomes suggests people are better off and therefore there is an increase in economic welfare. However, economic welfare will be concerned with more than just levels of income. For example, people’s living standards are also influenced by factors such as levels of congestion and pollution, levels of literacy and education, healthcare and social service provision etc. These quality of life factors are important in determining economic welfare. Real income is the income of individuals or nations after adjusting for inflation. It is calculated by subtracting inflation from the nominal income. Real gross domestic product (GDP) is a macroeconomic measure of the size of an economy after changes in inflation have been taken into account.
The problem of scarcity and the fact that choices need to be made leads us to the very important concept of opportunity cost. Every choice involves a sacrifice or trade off – in simple terms, choosing more of one thing means giving up something else in exchange. This is called opportunity cost, i.e. the sacrifice of the next best alternative. It is the direct result of scarcity and occurs every time a choice is made. The opportunity cost of a choice is what economists call a real cost – the cost of an item in terms, not of money, but of the resource, good or service that has had to be given up to obtain that item. The benefits forgone of the next best alternative use of resources.
Opportunity Cost is the ‘true’ cost of an economic decision. The true cost of an economic decision is always measured in terms of opportunity cost and never in monetary/financial terms. Opportunity cost is the benefits of something real which is actually given up. If we are talking about the opportunity cost of money it is the benefits of the alternative use of the money rather than the money itself which constitutes the true cost of a purchasing decision. For example the opportunity cost of spending £50m on a new warship is not the £50m itself but the benefits forgone of spending the £50m on a new hospital. Other opportunity cost examples: • •
The opportunity cost of the government’s decision to fight the Iraq war is the benefit that would have arisen from building 10 new schools. The opportunity cost of spending my monthly income is the benefit I would have received from saving it.
THE NATURE AND PURPOSE OF ECONOMIC...