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Basic economic problem - scarcity & choice

Author: Geoff Riley  Last updated: Sunday 23 September, 2012

The Economist's Dictionary of Economics defines economics as

"The study of the production, distribution and consumption of wealth in human society"

The purpose of economic activity

It is often said that the central purpose of economic activity is the production of goods and services to satisfy our ever-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 build more hospitals, roads, schools or luxury 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 we subsidise the purchase of solar panels for roofs?
  • Who is to receive goods and services? Who will get expensive hospital treatment - and who not? Should there be a minimum wage? Or perhaps a living wage? What are the causes and consequences of poverty in societies across the globe?

Scarcity

We are always uncovering of new wants and needs which producers attempt to supply by using factors of production. For a perspective on the achievements of countries in meeting people’s basic needs, the Human Development Index produced by the United Nations is worth reading. The economist Amartya Sen (Winner of the 1998 Nobel Prize for Economics) has written extensively on this issue.

Scarcity means we all have to make choices

Because of scarcity, choices must be made by consumers, businesses and governments. For example, over six million people travel into London each day and they make decisions about when to travel, whether to use the bus, the tube, to walk or cycle or work from home. Millions of decisions are taken, many of them are habitual – but somehow on most days, people get to work on time and they get home too in safety if not in comfort!

Key Point: Trade-offs and Choices

Making a choice made normally involves a trade-off – this means that choosing more of one thing can only be achieved by giving up something else in exchange.

“Every purchase is a trade-off, of course. If you decide to spend $20,000 on a new car, you’re saying that’s worth more to you than 20 bicycles or four vacations to Europe or the down payment on a house. Every choice involves opportunity costs; when you choose one thing, you’re giving up others. Plus, what you’re giving up isn’t always financial.Or obvious.”

  1. Housing: Choices about whether to rent or buy a home – both decisions involve risk. People have to weigh up the costs and benefits of the decision.
  2. Working: Do you work full-time or part-time? Is it worth your while studying for a degree? How have these choices been affected by the introduction of university tuition fees?
  3. Transport and travel: The choice between using Euro-Tunnel, a low-cost ferry or an airline when travelling to Western Europe.

Key Point: The Cost Benefit Principle

  • In many decisions where people consider the costs and benefits of their actions – economists make use of the ‘marginal’ idea, for example what are the benefits of consuming a little extra of a product and what are the costs?
  • Rational decision-makers weigh the marginal benefit one receives from an option with its marginal cost, including the opportunity cost.
  • This cost benefit principle well applied will get you a long way in economics!
  • But keep in mind that behavioural economics questions the rationality of many of our decisions!



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