The Economic Problem

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  • Created by: horlockm
  • Created on: 19-04-15 17:27

What the spec says we need to know about:

  • The Nature and Purpose of Economic Activity
  • Economic Resources
  • The Economic Objectives of Individuals, Firms and Governments
  • Scarcity, Choice and the Allocation of Resources
  • Production Possibility Diagrams
  • Value Judgements, Positive and Normative Statements

The nature and purpose of economic activity

The central purpose of economic activity is the production of goods and services to satisfy needs and wants, and thereby to improve economic welfare.

Everyone has certain needs in life- e.g. food, water, a place to live and so on. Everyone also has an infinite list of things they want- e.g. designer clothes, smartphones, holidays, houses, etc.

However, there's a limited amount of resources available to satisfy these needs and wants- resources are scarce.

These facts lead to a basic economic problem:

How can be available scarce resources be used to satisfy people's infinite needs and wants as effectively as possible?

Scarcity requires a careful allocation of resources. In economics, a wide range of things count as economic activity.

Since there's an endless array of things that could be produced and consumed, but only limited resources, this leads to three fundamental questions:

  • What to produce?
  • How to produce it?
  • Who to produce it for?

The agents in an economy can usually be thought of as:

  • Producers - firms or people that make goods or provide services
  • Consumers - people or firms who buy the goods and services
  • Governements - a government sets the rules that other participants in the economy have to follow, but also produces and consumes goods and services

Each of these economic agents has to make decisions that affect how resources are allocated. In a market economy, all economic agents are assumed to be rational, which means they'll make the decisions that are best for themselves. These decisions will be based on economic incentives, such as profit making or paying as little as possible for a product.

Considering people's incentives helps to answer those fundamental questions above:

  • What to produce? This will be those goods that firms can make a profit from.
  • How to produce it? Firms will want to produce the good in the most efficient way they can, in order to maximise their profits.
  • Who to produce it for? Firms will produce goods for consumers who are willing to pay for those goods.

Economic resources

The scarce resources (inputs) used to make the things people want and need (outputs) can be divided into four factors of production. These factors are land, labour, capital and enterprise.

Land includes all the natural resources in and on it:

  • As well as actual territory, land includes all the Earth's natural resources:
    • Non-renewable resources, such as natural gas, oil and coal
    • Renewable resources such as wind or tidal power, or wood from trees
    • Materials extracted by mining (e.g. diamonds and gold)
    • Water
    • Animals found in the area
  • Nearly all things that fall under the category of 'land' are scarce- there aren't enough natural resources to satisfy the demands of everyone


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