Basic Economic Problem 1

BASIC ECONOMIC
PROBLEM
LEARNING
OBJECTIVES
• The fundamental nature of economics - unlimited wants
and scarce resources and the need to make choices
• The three questions related to the economic problem and
its implications for an economy
• A definition of opportunity cost
• Production possibility frontiers and their relevance to the
concept of opportunity cost
WHAT IS ECONOMICS?
Economist, Lionel Robbins (1935),

Eco o ics is a scie ce hich studies
human behaviour as a relationship
between unlimited end and scarce
ea s hich ha e alter ati e uses
THE ECONOMIC PROBLEM
Unlimited Wants
Scarce Resources –
Land, Labour, Capital
Resource Use
Choices
BASIC ECONOMIC
PROBLEM
Contradiction between limited
resources and unlimited
human wants
The difference between scare

resources and overloading
demand for economic goods
Choices have to be made

when allocating resources
between competing uses
ECONOMICS PROBLEM
All societies face the problem of having to decide:
1. What goods and services to produce:

- Does the economy uses its resources to operate more hospitals or hotels?
- Does the National Health Service provide free IVF treatment for
thousands of childless couples?
2. How best to produce goods and services:

- Should school playing fields be sold off to provide more land for
affordable housing?
- Or are we contributing to the problem of obesity by selling off these
playing fields?
3. For whom to produce 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?
PPORTUNITY COST
Highest valued option

foregone
Exists whenever
choices need to be
made
SECTORS OF PRODUCTION IN THE
ECONOMY
Primary sector:
Extraction of natural
resources
e.g. agriculture, forestry,
fishing, quarrying, and mining
 Secondary sector:
Production of goods
e.g. motor manufacturing,
food processing, furniture
making
Tertiary sector:
Provide services
e.g. banking, finance,
insurance, retail, education,
travel, tourism
 Quaternary sector:
Information processing
e.g. education, research
and development,
information technology
OBJECTIVE OF ECONOMIC ACTORS
Consumers:
Rational decision makers
Maximise own satisfaction
Use limited income to but goods

and services which yield the
highest possible level of utility
Face problem of scarcity

Producers:
Rational decision makers
Maximise own welfare
Use limited resources to produce

goods and services which yield the
highest possible profit
In reality, pursue objectivities

different from pure profit
maximisation
Government:
Maximise welfare of the citizens of their
country
Act in the best interest of all
Not immediate obvious what are the

cost and benefit of a decision
No consensus about what value to put

on the gains and losses of different
groups
The medium between producers and

consumers
PRODUCTION POSSIBILITY
FRONTIER (PPF)
PPF shows the combinations of two or more goods that can be
produced using all available resources efficiently.
No ideal point on the cur e

Any point inside the curve – suggests resources are not being
utilised efficiently
Any point outside the curve – not attainable with the current level
of resources
Useful to demonstrate economic growth and opportunity cost
PPF is drawn as concave to the origin

Point X  unemployed resources or
when the economy uses resources inefficiently.
Points C, A or B  all resources in economy are fully employed
Point D  unattainable at the moment

Reallocating scarce resources from one product to
another involves an opportunity cost.
Increase output of capital goods (i.e. a movement from point A to point B)

then fewer resources are available to produce consumer goods
As opportunity cost of switching resources increases –

i.e. give up more of consumer goods to achieve gains in the output of
capital goods
PPF shifts outwards
E pa sio of ou tr ’s produ ti e pote tial
 Long-term economic growth
Increase in efficiency and productivity

 more can be produced with given resources
Advanced technology and innovation

improve production progress
Improved Technology in the computer industry
• assumed to affect the notebook computer producers only

• An outward shift of the PPF 
the opportunity cost of producing notebook computer has fallen.
• With same resources allocated to other goods,

greater output of notebook computer is possible
PPF shifts inwards
 Co tra tio of ou tr ’s produ ti e pote tial
Deep economic recession

( insufficient investment, business close,
unemployment)
Early retirement, delayed entry into

labour market by students
Over-exploitation of renewable
resources
War and natural disasters

POSITIVE AND NORMATIVE STATEMENT
Economics is concerned with 2 types of investigation
Positive Statement Normative Statement

 objective statements dealing  subjective statement with
with matters of fact or they value judgments
question about how things
actually are  cannot be supported or
 without obvious value-  opinion about how

judgments and emotions economics and market
should work
 can be proven to be true or
false  contain ords like should
and ought
 can be supported or refuted
by evidence
EXAMPLE OF POSITIVE
STATEMENT:
“The UK economy is currently operating on its
produ tio possi ilit ou dar
Lower taxes may stimulate an increase in the active

la our suppl
A national minimum wage is likely to cause a

contraction in the demand for low-skilled la our
EXAMPLE OF NORMATIVE
STATEMENT:
“The decision to grant independence for the Bank of
E gla d is u ise a d should e re ersed
The government is right to introduce a ban on smoking in

pu li pla es.
The level of duty on petrol is too unfair and unfairly

pe alizes otorists.
The government should increase the national minimum

wage to £6 per hour in order to reduce relative poverty.
SCARCITY AND
ECONOMICS
Scarcity (the bad news): we can’t reach all of our goals; there
aren’t enough resources.
Economics (the good news): we can get the most from the
resources we do have.

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BASIC ECONOMIC

Economist, Lionel Robbins (1935),

The difference between scare

Choices have to be made

1. What goods and services to produce:

2. How best to produce goods and services:

Highest valued option

Maximise own satisfaction

Use limited income to but goods

Face problem of scarcity

Maximise own welfare

Use limited resources to produce

In reality, pursue objectivities

Act in the best interest of all

Not immediate obvious what are the

No consensus about what value to put

The medium between producers and

No ideal point on the cur e

PPF is drawn as concave to the origin

Points C, A or B  all resources in economy are fully employed

Point D  unattainable at the moment

Increase output of capital goods (i.e. a movement from point A to point B)

As opportunity cost of switching resources increases –

Increase in efficiency and productivity

Advanced technology and innovation

• assumed to affect the notebook computer producers only

• With same resources allocated to other goods,

Deep economic recession

Early retirement, delayed entry into

War and natural disasters

Positive Statement Normative Statement

 without obvious value-  opinion about how

Lower taxes may stimulate an increase in the active

A national minimum wage is likely to cause a

The government is right to introduce a ban on smoking in

The level of duty on petrol is too unfair and unfairly

The government should increase the national minimum

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