Basic Economic Problems: Class Note

Subject

Economics

Topic

Basic Economics Problem

Level

The basic economic problems are the fundamental economic problem such as the issue of scarcity and how best to produce and distribute these scarce resources. As a result of scarcity, choices have to be made, The scale of preference helps in making sensible financial decisions and opportunity cost is the expense of foregoing the next best option while making a decision. A broader explanation of each economic problem will be discussed below.

SCARCITY

People do not have as much as they desire due to economic scarcity. The problem of scarcity emerges because the productive resources available in any society are restricted at any given time, yet human wants are limitless. As a result, the number of commodities and services that may be produced is restricted and insufficient to satisfy human needs.

One of the most important notions in economics is scarcity. It signifies that the demand for a product or service exceeds the supply of that product or service. As a result, scarcity might limit the options available to customers, who make up the economy in the end.

Every society is confronted with the economic dilemma of maximizing the use of limited, or scarce, resources. The economic problem exists because, while people’s needs and desires are limitless, the resources available to meet those needs and desires are finite.

As a result, every society must address four key economic issues.

WHAT TO PRODUCE?

Every society must decide in some way what goods and services to create and how much of each within any particular time period.

 HOW TO BE PRODUCED?

Each firm must decide how to utilize the inputs to achieve optimal resources allocation i.e. the manner of combination of factors of production in order to produce the maximum output quantum of goods and services possible.

FOR WHOM TO PRODUCE? That is, for which category of consumers are the goods being produced? Is it for the young, the old, or for both categories?

HOW TO FACILITATE FUTURE GROWTH?

The resources must be used at a rate that increases future production potential. The most fundamental economic problem that every civilization faces is scarcity. Goods and services would not be scarce if resources were not scarce, and there would be no need to save. As a result, studying economics would be unnecessary.

CHOICE

Choice refers to a consumer’s or producer’s ability to choose from a variety of goods, services, or resources to purchase or give. The ability to make one’s own decisions is viewed as a key sign of economic growth and progress.

As a result of scarcity, choices have to be made. Making a choice entails sacrificing something in order to obtain something else. 

SCALE OF PREFERENCE

A scale of preference is a collection of unfulfilled desires ranked according to their relative importance.  In other words, it’s a list of the ways we wish to satisfy our desires, arranged in priority order.

Moreover, It is defined as a list of all desires to be fulfilled, sorted in priority or importance order. The idea of the Scale of Preference underpins economics’ fundamental assumption that every economic agent acts rationally when making a decision.

For example, if Adams has N10,000 and he has to buy these items. He’ll have to go for the first three on the list. Later on, when he has more cash, he can go for the last two.

ITEMS TO BUY

PRICES (N)

A pair of Snickers

6,500

Chelsea Jersey Shirt

2,500

Perfume

1,000

Bluetooth Earpiece

5,000

Mobile Phone Internet Subscription

3,000

 

The scale of preference helps in making sensible financial decisions that, to some extent, maximize your satisfaction because you will be able to meet all of your immediate demands.

Basic Economic Problems

OPPORTUNITY COST

“In microeconomic theory, the opportunity cost of a particular activity option is the loss of value or benefit that would be incurred by engaging in that activity, relative to engaging in an alternative activity offering a higher return in value or benefit.”

The phrase “opportunity cost” was used by economists to describe the expense of foregoing the next best option while making a decision. The opportunity cost of a commodity purchased is the next most desirable commodity a buyer could have purchased instead. Mr. Adams, for example, wants 1kg of Mackerel fish and 1kg of chicken wings, both of which cost N1500. But, with only N1500 in his pocket, he opted to buy 1kg of Mackerel fish. The opportunity cost of 1kg of mackerel fish bought is a kg of chicken wings forgone.

“The concept of opportunity cost is central to the study of economics because it guides the individual, the firm, and the government to make rational decision on the use of scarce resources.  Opportunity cost is alternatively referred to as real cost or economic cost.”

It’s worth noting that the accountant’s perspective on cost (i.e. accounting cost) differs significantly from the economist’s perspective on cost (i.e. opportunity cost). The cost of a commodity purchased by a consumer or a factor of production purchased by a firm, according to accountants, is the amount of money spent for that commodity or productive resources. This is referred to as the “money cost” or “accounting expense.”

PRODUCTION POSSIBILITIES CURVE (PPC)

The Production Possibilities Curve (PPC) is a model that depicts the tradeoffs that occur when resources are allocated between the production of two goods. Scarcity, opportunity cost, efficiency, inefficiency, economic growth, and contractions can all be illustrated using the PPC.

PPC shows the various combinations of two goods that can be produced when all available resources are fully and efficiently utilized.

Product Combination

Groundnut (bags)

Noodle (cartons)

Opportunity Cost of an extra bag of Groundnut

A

0

200

0

B

1

170

-30

C

2

140

-40

D

3

90

-50

E

4

70

-60

F

5

0

-70

Table 1: PPC schedule

The Production Possibilities Curve (PPC) is a model that captures scarcity and the opportunity costs of choices when faced with the possibility of producing two goods or services. PPC schedule is depicted above in Table 1, The PPC in table 1 is drawn under the assumption that the society is using all its resources to produce only two goods – Groundnut and Noodles.

                                          Basic Economic Problems: Production Possibilities Curve

                                                      Production Possibilities Curve

Key terms under PPC

Efficiency: The PPC will always have full utilization of resources in production; efficient output combinations will always be on the PPC. Point on the PPC (from A to F) represents the many combinations of the two items that the economy can create if all available resources are completely exploited.

Inefficiency: Underutilization of any of the four economic resources (land, labor, capital, and entrepreneurial aptitude); inefficient production combinations are depicted as dots on the PPC’s interior. Any point inside the PPC, such as G, shows that some resources are either left completely idle or are not efficiently utilized.

Scarcity: The curve connecting points A and F forms a boundary that demonstrates that the country’s ability to produce bean and noodles at any given time is limited.

Economic Growth: a gradual improvement in an economy’s ability to create products and services; in the PPC model, economic growth is represented by a shift out of the PPC.

                                              Economy Growth

                                                   PPC demonstration of Economic Growth 

It is described as a steady expansion in an economy’s production capacity, resulting in increased output of products and services. An outward movement in the production possibilities curve from PPC 1 to PPC2 represents this.

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