The economic problem

The economic problem arises as a result of scarcity – while resources required by individuals, firms and governments are finite, the demand for these resources is infinite.

The economic problem facing all societies is how to use finite resources - land and natural resources, labour, capital and enterprise - to meet the specific wants and needs of a country's citizens.

The economic problem

The role of the entrepreneur is to combine the other scarce resources and organise production in such as way as to satisfy consumers' wants and needs in a profitable way.

Scarcity

Resources are scarce because they are either limited in quantity, or because they can only be put to one use at a time.

For example, a farmer faces both types of limitation. Firstly, the total quantity of land is physically limited which means that there is a limit to how much can be produced from the land. Secondly, land is limited in use, which means only one crop can be grown at a time.

Scarcity is a fundamental and inescapable fact of life. As a consequence of scarcity, choices must be made about how best to use these resources.

Trade offs and opportunity cost

Scarcity means that all economic agents must make choices. Owners of land must choose whether to use the land themselves, or to rent it out. Workers must choose which jobs to apply for, what training they need, and whether to work full-time or part-time. Capital owners must choose where to allocate their capital, and entrepreneurs must decide how best to use their skill and enterprise. Finally, consumers much choose how to allocate their income to achieve the maximum satisfaction, or utility.

Every time a choice is made a sacrifice is also made. In using land to grow wheat, the farmer cannot use the land to graze cattle. More of something means less of something else - trade-offs are a central feature of economic life. The sacrifice resulting from a decision is called opportunity cost.

Opportunity cost is regarded as the 'real' cost of any decision because it identifies what has been sacrificed by making the decision.

Different economic systems solve the economic problem in different ways. Market systems allocate resources through the interaction of consumers and producers within markets. Markets arise at all points in the flow of resources. Resources can also be directed through a central authority, such as a government, in what are called 'command economies'.


Economic systems

What are the benefits of a mixed economy?

Economic systems
Rational decision making

Are individuals rational in how they make decisions?

Rationality
Welfare

How does equilibrium create welfare?

Welfare