Study Note - The Basic Economic Problem: Scarcity and Choice

It is often said that the central purpose of economic activity is the production of goods and services to satisfy our changing needs and wants. The basic economic problem is about scarcity and choice. Every society has to decide: What goods and services to produce: Does the economy uses its resources to operate more hospitals or hotels? Do we make more iPhones and iPads or double-espressos? Does the National Health Service provide free IVF treatment for childless couples? How best to produce goods and services: What is the best use of our scarce resources? Should school playing fields be sold off to provide more land for affordable housing? Should coal be produced in the UK or is it best imported from other countries? Who is to receive goods and services: Who will get expensive hospital treatment - and who not? Should there be a minimum wage? If so, at what level should it be set?

An Economy refers to the system in which include production, consumption and exchange. In an Economy exists all the things like financial institutions, educational institutions, business firms, household, government etc. So, in an Economy each person or organization has their own wants for their existence. At the same time there may be shortage of resources to meet these wants.According to Lionel Robbins, human wants are unlimited, but the resources available to satisfy them are limited if an Economy has enough resources to meet the wants, means there is no any problem in Economy. But in reality it does not exist. All nations facing their own economic problems. This problem can be said the central problems of an Economy. Basically central problems of an economy or amarketcan be classified in to threeI) What produce in what quantities?II) How to produce?III) For whom to produce?These problems are showing briefly as follows.I)What produce in what quantity?It is one of the basic problem off an economy. To solve this each economy should answer for what produce and in what quantity produced in an economy of goods and services to satisfy the unlimited wants. Since the resources are alternative (same commodity can be satisfy different wants) the economy should try to optimum utilization of the available resources.II)How to produce?Mainly there are only two factors are available to produce goods and services. I.e. capital and labor. An economy should choose which feasible combination of factors of production. The combination refers to the ratio of capital and labor used for production.In the case of India (a labor rich country) the amount of labor may be more to the capital. But in USA (a capital rich country) may be use more amount of capital than the labor.

III)For whom to produce?It refers to how total output divided among needy persons or organizations.We saw the major problems of an economy are scarcity and choice.Since the resources are scarce and they have alternative uses a choice has to maid. We can say mainly choices may at two level. I.e. I) choice at the personal level and II) choices at national level. Both are discussed as below.

I) Choice at the personal levelSince the human wants are unlimited and income to satisfy them is limited. So, a consumer chooses such combination of commodities to satisfy his necessary wants with his limited income.II)Choice at the national levelHere the problem arise how factors of production shall be employed. Since the capacity of the economy is limited a choice has to be maid to how to utilize the available resources of an economy in an optimum manner.To describe or illustrate this (choice at national level) Professor, Paul Antony Samuelson introduced the Production Possibility Curve (PPC) concept in his book Principles of Economics.

Unlimited WantsHuman beings, in order to survive need a lot of things. Some of these things are very important for our existence. For example, food, clothing, water, shelter and air. These things can be classified asNeeds. Apart from this there are things which are needed by us but they are not important for our survival and we can live without them also. For example, going on an expensive holiday, owning a 57 inches Plasma TV. These are known asWants. This list is never ending and is continuously increasing.Limited ResourcesOn the other hand, we have limited resources to produce these goods and services we want. There are not enough car factories to provide cars to everybody on earth. Everything on this planet has some limits except for our Wants.When unlimited wants meet limited resources, it is known as Scarcity.

Alternative UsesAll the resources we have on this planet can be utilised in a number of way. They have alternative uses. For example, a piece of land can be used for making a factory, or doing farming or constructing a school and so on. Therefore, we have tochoosewhat is best for us. If we talk from an economist point of view it means making the optimum use of resource available.Opportunity CostThough we have alternative uses, we have to select the best way to use these resources. When we choose best alternative, the next best alternative which is left out is known as the Opportunity cost of making a choice. In other words, the benefits we lost and could have achieved from the next best alternative.

Examples of Opportunity CostA person who invests $10,000 in a stock denies themselves the interest they could have earned by leaving the $10,000 dollars in a bank account instead. The opportunity cost of the decision to invest in stock is the value of the interest.If a city decides to build a hospital on vacant land it owns, the opportunity cost is the value of the benefits forgone ofthe next best thingwhich might have been done with the land and construction funds instead. In building the hospital, the city has forgone the opportunity to build a sports centre on that land, or a parking lot.Economic ProblemThe problem then becomes how to determine what is to be produced and how the factors of production (such as capital and labour) are to be allocated. Economics revolves around methods and possibilities of solving the economic problem.

The basic economic problem is that resources are scarce relative to the purposes to which they could be put. As a result choices have to be made about how to use resources. The basic economic problem is thus frequently referred to as 'scarcity and choice'. A resource is a means of support. A resource from the point of view of business studies can be regarded as any feature of our environment that helps to support our well-being.

There are two main types of resource:1. Physical or natural resources - such as oil, climate, water, minerals, forests and fisheries.2. Human resources - people and their various skills.If we were to take stock of the world's existing bundle of resources we would find that there are severe limitations to its ability to meet our infinite wants.

ScarcityScarce resources can be broken down into four key ingredients: land, labour, capital and enterprise. Land includes all natural resources; labour includes all physical and mental effort; capital includes machinery and other items that go into further production; and enterprise is the art of combining the other three factors in the production process.Scarcity can be seen as resulting from the lack of availability in resources, from people's insatiable wants, or from a combination of the two.Most large multinationals have cut down the range of brands they produce in recent years. For example, BIC the producer of pens, lighters, and razors has consolidated around 150 lines from a much larger range. This is so that it doesn't spread its resources too thinly in competing in global markets.Because resources are scarce and most of our wants are extensive, a choice has to be made about how to use scarce resources in the best way. This rule applies to organisations, society as a whole, and to individuals.

Explain the 3 economic questions that all economic questions that all economies face because of the basic economic problem.

The basic economic problem is there are scarce resources to produce wants and needs of the people. So firms confront the three basic economic questions of what to produce, how to produce and for whom to produce.

As we cannot produce everything, we need to decide what to produce and in what quantities. It determines the allocation of scarce resources amongst alternative uses. So we have to choose for example, whether to produce lots of goods and services, such as food, clothing and vehicles to improve our standard of living or whether we to produce lots of military hardware to improve our defenses.

Since resources are scarce to produce unlimited wants we need to consider how resources can be used to produce best outcome. We need to consider how we can get the maximum use out of the resources available to us. But other issues beside purely economic concerns should be considered when deciding how to produce. For example, through slavery or forced labor we could produce more goods and services in an economy but there is a moral objection to such arrangement crop yielding could be increased through genetically modified plants but this may lead to damage to the ecosystem. Economist uses the term labor intensive and capital intensive to describe the alternative methods.

We cannot satisfied all the wants of all the population, decisions have to be taken concerning how many of each person's wants are to be satisfied which leads to income distribution. We need to decide whether everyone is going to have a more or less equal share of what others. Statistics reveal great disparity since 15% of the population of rich countries for example, USA, Western Europe, Canada and Japan receives approximately 80% of world income while 57% of the world's population in poor countries for example; India, China, Indonesia, etc. receives only 5%. Hence the world economy is essentially producing for consumption by rich nations only.

The basic economic questions are inextricably linked to the working of the price system. When the price of good increases, consumers will want less but producer will want to sell more. These responses in turn determine what, how and for whom to produce.