On completion of this chapter you should know:
■ what is meant by the fundamental economic problem of
limited resources and unlimited wants
■ what is meant by scarcity and the inevitability of
choices that have to be made by individuals, firms and
■ what is meant by opportunity cost
■ why the basic questions of what, how and for whom
production takes place have to be addressed in all
■ the meaning of the term ‘ceteris paribus’
■ what is meant by the margin and decision making at
■ the importance of the time dimension in Economics
■ the diff erence between positive and normative
■ what is meant by factors of production, namely land,
labour, capital and enterprise
■ what is meant by the division of labour
■ how resources are allocated in market, planned and
■ problems of transition when central planning in an
economy is reduced
■ the characteristics of a production possibility curve and
how opportunity cost can be applied
■ the functions and characteristics of money and types
■ how goods can be classified into free goods,
private goods, public goods, merit goods and
■ the problems associated with information failure
One economic problem or many?
Economists must deal with the entire economic sphere problem. You may have read about The pain of unemployment and poverty; you may have Read information about inflation or the difficulty of hearing Politicians discuss the exchange rate crisis at night news. You may also know about the surrounding debate Such as a severe lack of skilled labor, The benefits of expanding international trade liberalization Global warming and population explosion issues In many developing economies. Although extensive A series of questions on which economists have been trained, They often talk about “economic issues”. this is Fundamental problems arising from all other problems. This This is the fact that we lack the resources to satisfy us Unlimited demand. Because of this problem, this is Sometimes called the scarcity problem, we have to One option, the task of the economist is to explain and Analyze the nature of the choices faced by economic agents, such as As consumers, producers and governments.
Resources: inputs available for the production of goods
Wants: needs that are not always realised.
Scarcity: a situation in which wants and needs are in
excess of the resources available.
Choice: underpins the concept that resources are scare
so choices have to be made by consumers, firms and
In Economics we categorise the resources available to us into four types. Th ese are known as factors of production:
1 Land: This factor is the natural resource. It includes the surface of the earth, lakes, rivers and forests. It also includes mineral deposits below the earth and the climate above, as well as the small area of land that makes up a farm or factory. The reward for owning land is the income that is generated.
2 Labour: This factor is the human resource, the basic determinant of which is the nation’s population. Not all of the population is available to work, because some are above or below the working population age and some choose not to work. The reward for labour is the wage or salary that is paid.
3 Capital: This factor is any man-made aid to production. In this category we would include a simple spade and a complex car-assembly plant. Capital goods help land and labour produce more units of output – they improve the output from land and labour. The reward to capital is the rate of return that is earned. These three factors are organised into units of production by firms.
4 Entrepreneur: This factor carries out two functions. First, the enterprise factor organises the other three factors of production. Second, enterprise involves taking the risk of production, which exists in a free enterprise economy. Some firms are small with few resources. The functions of enterprise are undertaken by a single individual, the entrepreneur. In larger, more complex firms the functions are divided, with salaried managers organising the other factors and shareholders taking the risk. The return for enterprise is the profits that are made.
Choice and opportunity cost
Given limited resources and unlimited wants we have
to choose which wants to satisfy. Th e true cost of any
choice we make between alternatives is expressed by
economists through the notion of opportunity cost.
Th is looks at the cost of our choice in terms of the best
alternative forgone. For example, suppose you were
given a $15 gift voucher for your birthday. You could
either buy a new DVD that costs $15 or two paperback
books for $7.50 each. It is clear that you could not have
the DVD and the books. Th e opportunity cost of the
DVD, therefore, is the two paperback books. Th e value
of the concept of opportunity cost is that it brings home
to us the real cost of our choices. It can be applied in
a variety of contexts in Economics and is helpful for
economic decision-makers, such as households, fi rms
The time dimension
We live in a world of change. Change is all around us in
our lives, our work and in the ways in which economies
function. In order to take change into account, it is oft en
necessary to specify the time dimension; in other words,
to assess how over time change can infl uence the concepts
that economists are seeking to model and explain. Th is
can be done very eff ectively in terms of the factors of
Th e short run is a time period in which it is possible
to change only some inputs. Typically it is when labour,
a variable factor of production, can be increased or
decreased to change output. So, with all other factors of
production remaining the same (ceteris paribus), a fi rm
taking on more workers may be able to increase its output.
In the long run, it is possible for all factors of
production or resources to change. So, in the long run, a
fi rm may improve the quality and quantity of its capital
by building a new factory to increase its output. Th is will
usually allow it to be more effi cient since the fi rm has had
time to evaluate how best this can be done successfully
and effi ciently. Th e very long run is where not only are
all factors of production variable, but all other key inputs
are also variable. Th ese key inputs can include technology,
government regulations and social considerations.
Very long run: time period when all key inputs into
production are variable.
It should be clear that it is not possible to put an exact
timescale on any of these time periods. Just what they are
likely to be will depend on particular circumstances.
The planned economy
Like the market economy, the command or planned
economy in its purest form exists only in theory. In this
second type of economy, the government has a central
role in all decisions that are made and, unlike the market
economy, the emphasis is on centralisation. Central
planning boards and organisations make decisions in enterprises that are state-owned or under state regulation
and control. In a market economy, consumer sovereignty
infl uences resource allocation, whereas in a command
economy it is central planners who determine the
collective preferences of consumers and manufacturing
enterprises. Th e planned economies of the past 50 years
or so have their economic logic in the Marxian criticism
of the market economy. Th is particular objection was
essentially one of class confl ict between the wealthy
owners of capital and the poor working classes who
provided this wealth through the production process.
Marx was also critical of the built-in unemployment
arising out of the market system. For example, he had
observed the trend to replace labour with machines
(capital) and the inability of labour to secure higher wages.
Under a planned economy, unemployment is not an issue.
Marx was also very concerned about the way in which the
market economy fostered the concentration of productive
resources in the hands of large monopolistic industrial
and commercial organisations. As such he maintained
that they corrupted the workings of the market and, if
powerful enough, could exert pressure on governments.
Retrospectively, and in the light of empirical experience,
economists have with some justifi cation concluded that
Marx’s criticisms were excessive. Nevertheless, his general
recommendation that more centralisation should occur
and that more emphasis should be placed on economic
planning has been applied by those countries that have
pursued the notion of a planned economy.
So, the key features of a planned economy are that
central government and its constituent organisations take
■ the allocation of resources
■ the determination of production targets for all sectors of
■ the distribution of income and the determination of wages
■ the ownership of most productive resources and property
■ planning the long-term growth of the economy.