LESSON 1 The Economic Problem (Lecture)

1. What's the basic economic problem? The basic economic problem is based on two things: a) The resources used to make goods and services are scarce Scarcity of resources means that the resources used aren't enough to support the human population and that they will soon run out. This is particularly the case with nonrenewable resources such as fossil fuels, gold etc. Any resources that are not scarce (non-renewable resources) are called free goods. However, even the clean air that we breathe in and the water that we drink are limited in amount and may eventually run out! b) The human wants are unlimited Firslty, we should know the difference b/w needs and wants. Needs are all those things which are necessary for a man to survive. They can be categorized as food, shelter and clothing. These are the basic necessities. However, we humans don't just stop there. We tend to use the natural resources into making things which would allow us to lead a 'comfortable' life. Television, computers, cars are some examples. Though some might argue that these things are rather necessary, however they are not. Early men survived

without these things now, didnt they? The point of concern is the fact that we humans have unlimited wants. After buying a PS2 we need a PS3 and then a PSP, and so the list goes on. Even the necessities are being over consumed. While some have a huge house just for a few family members, others tend to live in small ones with a crowded family. Similarly obesity is on the rise. With limited resources and unlimited wants... things become a bit tricky! 2. Alternative Uses We have learned that wants are unlimited but the resources used to produce the goods and services to satisfy these wants are limited. That is there is scarcity. Nobody can have sufficient goods and services to satisfy all their needs and wants, so people must choose which wants they will satisfy. Choice is necessary because scarce resources can be used in lots of ways to make many different goods and services. Scarce resources have alternative uses. 3. Opportunity Cost When comes a choice, there is always an opportunity cost. Of course with limited resources we can't have it all. So something must be bought at the expense of the other. For e.g if I have Rs.100. With this cash I want to buy a burger and CD. However, I find out that its not enough; Burger costs Rs.70 and CD costs Rs.50. Now with 'limited' cash i will have to make a choice. I can either enjoy a burger or buy a CD. Lets suppose I go with the burger. In this case the CD will be my opportunity cost. To summarize, opportunity cost can be defined as 'the next best alternative forgone'. 4. Conflict of Interests and how to make the right choice? On a micro level, making a choice is rather easy. However, on a macro level making a choice is very difficult as one

decision affects thousands of people. For e.g you are a part of the government of Pakistan. You have limited funds. If resource are used in one way, for example, to build a motroway, they cannot be used in some other way , for example, as farm land. While the motorway may satisfy the wants of motorists, it does not satisfy the wants of farmers, nature lovers and people who live near the motorway who must suffer the noise and pollution that it causes. Clearly choice involves a conflict of interest. Therefore, you will have to consider all the options and its consequences. So now, how do governments make the right choice? Governments conduct , what is called, a cost-benefit analysis. This is usually done by considering the social costs and social benefits of the options available (we will discuss these terms in the later sections). Rationally, the option with higher social benefits and lower social costs is chosen. Ofcourse, opportunity cost is also involved. For e.g if the government decides to build a school rather than a hospital, in that case the hospital is the opportunity cost.

5. Resources and their classification Resources can be defined as the basic inputs required to obtain a specific output. In economics we classify resources into four general categories - also known as the factors of production. There are four factors of production: Land, Labour, Capital and Entrepreneur. Land:Land consists of all those resources which are directly related to nature and thus can be obtained from nature.

Such resources include forests, mining, fishing, land for farming etc. Labour:Labour can be considered as the human resources available. This sector includes all the workers which are working in an organization. From a manager in a company to a peasant working in a farm, all come under labour. Capital:Capital consists of all those resources which are manmade. Examples of such resources include machinery, plants etc. Capital goods are actually those good which are used to produce other goods. Entrepreneur:Entrepreneur is the person with the brains behind a business. He is the risk taker and the person with the idea. Many would argue that entrepreneur should fall under labour rather than having a specific category but such is the importance of an entrepreneur that he has to be respected as factor of production.

Please bear in mind that a production process may not be using all of the factors of production. For e.g crops produced in a small farm may only contain 2 factors of production that is land (on which the crops are being planted) and labour (farmers working on the farm). However a farm being supervised on a large scale may be using all four factors of production, such as tractors (which is capital) and may be supervised by an entrepreneur.

Question/Answer session: Q. 'If we work hard enough, the problem of scarcity may be solved'. Do you agree with this statement? Give reasons to support your answer. Ans. I sincerely believe that problem of scarcity cannot be solved permanently, though it can be lessened. It's true that technological advancements have resulted in mass productions, and have allowed renewable resources to be used to produce useful products. However the human wants continue to increase proportionally. Furthermore the resources will always remain limited relative to the human wants. Thus the problem of scarcity can never be solved (otherwise there wouldn't be a need to study the subject, Economics!)

Q. The government is facing a tough situation. It has the option of reducing oil prices by granting subsidies, or use that money to build some hospitals. What would be the opportunity cost of the government of granting subsidies rather than building hospitals? Evaluate. Ans. The simple answer would be : the increased number of patients. However the question says evaluate. So to evaluate my answer I will link 'increased number of patients' to the economy's output. If there will be a lack of hospitals in a place, it will result in less people being cured. Thus the efficiency of many workers will fall down, if they continue to work in their illness. When the efficiency of workers will fall down, the output will also fall. So indirectly, the opportunity cost would be the decreased output.

Q. Which factor of production do you think is most important and why? Ans. This question is open to any answer (as long as the reasons are strong enough to support the argument). However the most easy answer for this Q is entrepreneur. The reason why he is so important is that he is the one who is willing to take the risk of setting up a new business. He is the originator of the idea behind a business. An entrepreneur also manages all the other factors of production into making something useful.

For further guidance: Consult Chapter one of the book 'Economics: A Complete Course' by Brian Titley.