The Economic Problem

The Economic Problem

Limited Resources - Unlimited Wants

Learning Objective 01
Define the Economic Problem and explain the reasons why it exists.
Learning Objective 02
Appreciate the problem of scarcity and explain the issues surrounding it.
Learning Objective 03
Explain the difference between Economic Goods and Free Goods.


The Economic Problem

People living in rich or poor countries would like to have more goods and services. People living in slums or poor housing conditions would wish for better quality houses and living conditions. Rich people would want better houses and living conditions, for example, a house with a swimming pool.
However, most people are not able to have what they usually desire to have, whether rich or poor. This is because the resources to make goods and services including workers and capital are scarce or limited in supply.

Scarcity continues to exist. Ironically, more goods and services are being produced these days than before. At the same time, human wants have been exceeding the growth of economic resources. People still want more products than the available resources to produce them. These wants continue to grow and change over time.

The fact that people need to choose what products to buy, which course to study, which jobs to do and which products to produce clearly reveals the lack of resources. As consumers, we cannot have everything that we want, simply because we have limited incomes. As a student, you must pick and choose the subjects to study for your IGCSE©. Workers cannot do two jobs at the same time. Time is limited in supply. Farmers cannot grow rice and pineapples on the same land. They must select one crop as land is scarce.
Goods in economics are classified into economic goods and free goods. Scarce resources are needed to produce economic goods. Free goods like the clean air we breathe are made readily available by nature and need not be produced using scarce resources.
Goods and services required for human consumption can be classified into basic needs and wants. Basic needs like food clothing and shelter are needed for survival. Wants are not necessary for survival but give us entertainment and pleasure.

Scarce resources have alternate uses. As they are limited in supply, choices must be made as to which goods and services need to be produced and which must be given up. Making such decisions would lead to conflict as some people will be deprived of their wants. In economics, such decisions involve a cost and is the cost related to making choices. As soon as a decision is made to choose one alternative over another, the person is giving up the benefit he or she would have gained if they had purchased it. This is known as Opportunity Cost.


Factors of Production

Resources are also known as factors of production and can be classified into land, labour, capital and enterprise. Land in general terms include the earth in which crops are grown and on which offices and factories are built. However, in economics land has a broader meaning. It includes any natural resource which is used in production.

So, besides the land itself, it also includes what is beneath the land such as minerals and coal deposits; what grows naturally on the land such as rainforests. Rivers, seas and the oceans are also part of land and all living creatures found in them such as fishes and crabs.
Land is also referred to as the facilities and amenities that are used to attract tourist into a country. Tourism is a service where a country’s climate, beaches the safari parks and other natural beauties are used.

Labour covers all human effort both mental and physical effort in producing goods and services. A street sweeper, a car mechanic and a doctor all contribute their labour either physically or mentally.

Capital is any man-made (manufactured) good used to produce other goods and services. Capital goods are not wanted for their own sakes, but for what they can produce. Consumer goods, such as food, clothing and computer games are wanted for the satisfaction they provide to the owners. A glass of lemonade bought from a fruit stall will satisfy the thirst of the person who bout it. When deciding whether a good is a producer or consumer good, it is important to consider the purpose of its intended use. A laptop is a producer good when it is predominantly used by an insurance firm to process insurance claims, where a service is produced. If however, the laptop is used to play games or watch a movie, then it is classified as a consumer good.

Enterprise is the willingness and ability to bear uncertain risks and business decisions of a business. Entrepreneurs are the people who organise the other factors of production and who crucially bear the risk of losing their money invested into the business – in the event of business failure. Entrepreneurs decide what to produce – after considering consumer demand and how to produce it.

Goods and services produced by these resources can further be classified into public and merit goods. Public goods are produced by the public sector as some of these goods are not fully paid by the consumers. Public goods are offered for free or at subsidised rates. Merit goods such as education and healthcare are produced by the private and public sectors.


Division of Labour

The ability to consume goods and services on a large scale is made possible by the concept of specialisation and exchange. Consumption and production cannot take place on a grander scale without these two economic activities.

The word economy is used to describe an area of a country in which goods and services are produced. These areas can be local, regional, national and international. The production of goods and services is usually undertaken by the private as well as the public sectors.

The term production is used to describe an activity to make goods and services by producers in order to satisfy the needs and wants of consumers.

The term consumption is used to describe the act of consuming goods and services by consumers and involves spending. Exchange is a common feature of modern society which relies on others for the consumption of goods and services.

Through specialisation, people can earn incomes which they will exchange for the goods and services they need and want. The act of exchanging is described as trade in economics and can take place between people of a country or between countries at an international level.

Division of labour is part of the specialisation process. As specialisation means a person or activity is based on focused skills and expertise, division of labour can be viewed from the same perspective. Instead of building a whole car, workers will concentrate in assembling individual components before a whole car rolls out of the factory.

The idea is to increase the speed of production as well as to save time. This will lead to higher output levels. Division of labour will also make best use of worker skills and abilities as workers will be able to concentrate on those tasks, they are good at. Machines can also be used more effectively in the production process.

However, despite its known advantages, division of labour has certain drawbacks. Work becomes repetitive and leads to boredom. It could also lead to health and safety issues as boredom can lead to mistakes and accidents. Division of labour can only take place in large areas as most of the production takes place at various locations in a factory. As such, workers may feel alienated and isolated from other staff and workers within the organisation. As division of labour breaks down tasks, work becomes inter-dependent. If a worker is absent, then work in an assembly line may get disrupted and affect production. As the idea behind division of labour is speed and bigger outputs, products produced will become standardised and look and feel similar with each other.

Lesson Summary & FAQs

Is water a Free Good?

Free goods are items that humans need or want which are available without limit. Water taken from the rivers, streams and ponds is a free good as it is readily made available by nature. Scarce resources are not used to produce water taken from the river.

If however, water is bottled and sterilised in a factory, then it is referred to as an economic good as resources like labour, machines and enterprise is used to produce it.

Similarly oxygen (a need for survival) is available through the air we breathe. However, oxygen made available in tanks in hospitals is an economic good because it is made using scarce resources.

What are Factor Rewards?

The only way to make scarce resources available for productive use is to pay money to obtain them. In other words a value is created. Apart from volunteer and charity work, people are not willing to offer their skills, time and effort for free.

Similarly, people will invest in a firm if they are sure to obtain some value in return.

Factor reward is a term to describe the payments received and offered to land (rent), labour (wages), capital (interest) and enterprise (profits) for their contribution to a productive activity.

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