Lecture 2: The Economic Problem PDF

Summary

This document explains the economic problem, which is the problem of how to make the best use of limited resources to meet unlimited needs. It introduces concepts including goods, services, and various types of resources. The document also explores the idea of scarcity and how different types of goods are categorized.

Full Transcript

**Lecture 2: The economic problem** All societies face the *economic problem*, which is the problem of how to make the best use of limited, or scarce, resources. The economic problem exists because, although the needs and wants of people are endless, the resources available to satisfy needs and wan...

**Lecture 2: The economic problem** All societies face the *economic problem*, which is the problem of how to make the best use of limited, or scarce, resources. The economic problem exists because, although the needs and wants of people are endless, the resources available to satisfy needs and wants are limited. Economics is defined by this economic problem; in each of the remaining chapters, this definition will be discussed and developed into a clear description of the science of economics. **Economics is a social science that studies how society chooses to allocate its scarce resources, which have alternative uses, to provide goods and services for present and future consumption** Let's break down this definition into clear words **What are goods and services?** A good is anything that fulfills a need, which is the primary goal of production---providing goods that meet demands. Goods are produced to be consumed, thereby satisfying those needs. A product can be either tangible or intangible. Tangible goods include physical objects like bulldozers or pizzas, while intangible goods, such as healthcare or education, are referred to as services. Both goods and services fulfill needs and can therefore be classified as products. **Resources** Satisfying wants requires the use of resources, also known as inputs or factors of production. These resources are categorized into land, labor, capital, and entrepreneurship. Land refers to the earth itself and the natural resources it provides. Labor is human effort, both physical and intellectual. Capital, in this context, refers not to money but to man-made tools of production---goods that have been created to help produce other goods. **What are sustainable resources?** A resource is anything that is useful to people. Natural resources can be divided into **renewable** and **non-renewable** resources. A **renewable resource** can be used again and again, so is more sustainable, eg water, wind, wood, sun and wave energy. A **non-renewable resource** will eventually run out, so it is not sustainable in the long run, eg fossil fuels such as gas, oil and coal. There is only a finite supply of non-renewable resources. All resources, both non-renewable and renewable, need to be carefully managed. For example, you can use a non-renewable resource in a way that helps to lengthen its use, eg re-using old tyres in road building materials. Some renewable resources may become polluted or overused by man. **Classification of goods:** Goods can be made either for direct consumption, as **consumer goods**, or to help create other goods, as capital goods. **Capital goods**, such as a mechanic\'s wrench or a school building, are produced resources that combine with other inputs like land and labor to generate more output. A good may be classified as a consumer or capital good depending on its use. For example, a personal computer used for playing games is a consumer good, but when used for work, like writing a textbook, it becomes a capital good. To determine whether a good is for consumption or production, ask if it will be used directly by consumers or to create more **goods. If it\'s for direct use, it\'s a consumer good; if for further production, it\'s a capital good.** **Classification** **Type of Goods** **Characteristics/Explanation** **Examples** -------------------------- --------------------- --------------------------------------------------- ----------------------------------- By Nature of Consumption Private Goods Excludable, rival in consumption. Food, cars, clothing By Nature of Consumption Public Goods Non-excludable, non-rival in consumption. Street lighting, national defense By Elasticity Normal Goods Demand increases with income. New clothes, electronics By Elasticity Inferior Goods Demand decreases with income. Generic brands, second-hand goods By Elasticity Luxury Goods Demand increases significantly with income. Designer clothes, luxury cars By Durability Durable Goods Long-lasting, provide utility over time. Cars, furniture, appliances By Durability Non-Durable Goods Consumed quickly, need frequent replacement. Food, toiletries By Production and Use Consumer Goods Consumed by end-users for personal/household use. Groceries, clothing By Production and Use Capital Goods Used in production of other goods/services. Machinery, factories, tools By Market Competition Substitute Goods Goods that can replace each other. Tea and coffee By Market Competition Complementary Goods Goods that are used together. Cars and gasoline **Scarcity -- definition** The problem of scarcity is regarded as the fundamental economic problem arising from the fact that, while resources are finite, society's demand for resources is infinite. Scarcity is a relative rather than an absolute concept -- for instance, while water covers most of the earth, an economist would still consider it scarce because the demand for water exceeds its availability for different uses. Resources are limited; and scarcity arises from the relationship between how much of resource exist and how much of is desired. Resources are scarce because we have more uses for them than there is supply. Now imagine a world without scarcity " **where all goods are free**" this would mean people could have unlimited access to everything they desire without sacrificing something else. However, few goods, if any, are truly free. Air might seem free, but even clean air can be scarce in certain areas, like smog filled cities, people often pay to avoid pollution. **Free goods** A free good is one that is so abundant that its consumption does not deny anyone else the benefit of consuming the good. In this case, there is no opportunity cost associated with consumption or production, and the good does not command a price. Air is often cited as a free good, as breathing it does not reduce the amount available to someone else. **Limited resources** Resources are limited in two essential ways: - *Limited in physical quantity*, as in the case of land, which has a finite quantity. - *Limited in use*, as in the case of labour and machinery, which can only be used for one purpose at any one time. **Characteristic** **Explanation** ------------------------ -------------------------------------------------------------------------------------------------- Essential for Survival Basic requirements for life, like food, water, and shelter. Universal Needs are common to all humans regardless of culture or location. Limited in Number Needs are finite, unlike wants which are unlimited. Non-Satiable Once satisfied, needs arise again (e.g., hunger after eating). Hierarchical Needs follow a hierarchy, starting from basic to higher-level needs (e.g., Maslow\'s hierarchy). Vary by Intensity Some needs are more urgent than others (e.g., air vs. esteem). Can Lead to Motivation Unmet needs drive people to act (e.g., hunger drives the search for food). Impact Well-being Lack of needs negatively affects physical and mental well-being. Objective in Nature Needs are measurable and objective, unlike wants which are subjective. **Choice and opportunity cost** *Choice* and *opportunity cost* are two fundamental concepts in economics. Given that resources are limited, producers and consumers have to make choices between competing alternatives. Individuals must choose how best to use their skill and effort, firms must choose how best to use their workers and machinery, and governments must choose how best to use taxpayer's money. Making an economic choice creates a sacrifice because alternatives must be given up. Making a choice results in the loss of benefit that an alternative would have provided. For example, if an individual has £10 to spend, and if books are £10 each and downloaded music tracks are £1 each, buying a book means the loss of the benefit that would have been gained from the 10 downloaded tracks.  Similarly, land and other resources, which have been used to build a school could have been used to build a factory. The loss of the *next best* option represents the real sacrifice and is referred to as *opportunity cost*.  The opportunity cost of choosing the school is the loss of the factory, and what could have been produced. It is necessary to appreciate that opportunity cost relates to the loss of the next best alternative, and not just any alternative. The true cost of any decision is always the closest option not chosen. **Samuelson's three questions** America's first Nobel Prize winner for economics, the late [**[Paul Samuelson]**](https://www.nobelprize.org/nobel_prizes/economics/laureates/1970/samuelson-bio.html), is often credited with providing the first clear and simple explanation of the economic problem -- namely, that in order to solve the economic problem societies must endeavour to answer three basic questions -- What to produce? How to produce? And, For whom to produce? **What to produce**? Societies have to decide the best combination of goods and services to meet their varied wants and needs. Societies must decide what quantities of different resources should be allocated to these goods and services. **How to produce**? Societies also have to decide the best combination of factors to create the desired output of goods and services. For example, precisely how much land, labour, and capital should be used to produce consumer goods such as computers and motor cars? **For whom to produce**? Finally, all societies need to decide who will benefit from the output from its economic activity, and how much they will get. This is often called the problem of distribution.\ Different societies may develop different ways to answer these questions.

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