Section 1 (Ch:1 - 4) Notes & Practice by Sana Ahmed

Section 1: The Basic Economic Problem

Cambridge Syllabus:

1.1 The nature of the economic problem

1.1.1 finite resources and unlimited wants
1.1.2 economic and free goods
Definition and examples of the economic problem
in the contexts of: consumers; workers;
producers; and governments.
The difference between economic goods and free
goods.

1.2 The factors of production

1.2.1 definitions of the factors of production and their rewards
1.2.2 mobility of the factors of production
1.2.3 quantity and quality of the factors of production
Definitions and examples of land, labour, capital and enterprise. Examples of the nature of
each factor of production.
The influences on the mobility of the various factors.
The causes of changes in the quantity and quality of the various factors.

1.3 Opportunity cost

1.3.1 definition of opportunity cost
1.3.2 the influence of opportunity cost on decision making
Definition and examples of opportunity cost in different contexts.
Decisions made by consumers, workers, producers and governments when allocating their
resources.

1.4 Production possibility curve diagrams (PPC)

1.4.1 definition of PPC
1.4.2 points under, on and beyond a PPC
1.4.3 movements along a PPC1.4.4 shifts in a PPCGuidance
Definition, drawing and interpretation of appropriate diagrams.
The significance of the location of production points.
Movements along a PPC and opportunity cost.
The causes and consequences of shifts in a PPC in terms of an economy's growth.

This set contains:

➢ NOTES
➢ MCQ Practice - Paper 1
➢ Theory Practice - Paper 2

1
 Section 1 (Ch:1 - 4) Notes & Practice by Sana Ahmed

Section 1: The Basic Economic Problem

The basic economic problem - unlimited human wants exceeding finite resources.
Resources are factors used to produce goods (such as bread, television, cars) and provide
services (such as banking, insurance, transport).

The economic problem leads to scarcity - a situation where there is not enough to satisfy
everyone’s wants.

Scarcity leads
to choice which leads to the concept of opportunity
cost - the cost of
choice. This is because scarce resources
have alternative/competing uses.

The scarcity of resources and unlimited

human wants and needs gives rise to the
allocation problem of resources.
All economies need to answer the three main basic
questions:

1) What to produce?
2) How to produce?
3) For whom to produce?

Economic resources/factors of production are used to produce goods & services to satisfy
human wants and needs.

There are four factors of production:

Land
Labour
Capital
Entrepreneur

Production therefore involves using resources/inputs to produce output for consumers.

2
 Section 1 (Ch:1 - 4) Notes & Practice by Sana Ahmed

Factors of Production:
Refer to the resources required to produce a good or service.

Land:

_________________________________________________________________________

_________________________________________________________________________

Labour:

_________________________________________________________________________

_________________________________________________________________________

Capital:

_________________________________________________________________________

_________________________________________________________________________

Enterprise:

_________________________________________________________________________

_________________________________________________________________________

3
 Section 1 (Ch:1 - 4) Notes & Practice by Sana Ahmed

The mobility of factors of production:

1) Geographical mobility: refers to the extent to which labour is willing to and able to
move to different locations for employment purposes.
2) Occupational mobility: refers to the extent to which labour is able to move
between jobs. Retraining and upskilling help workers to improve occupational
mobility.

Mobility of land:
Land is occupationally mobile and geographically immobile.

Mobility of labour:
❖ Differences in the price and availability of housing in different areas and countries.
❖ Family ties.
❖ Differences in educational systems in different areas and countries.
❖ Lack of information.
❖ Restrictions on the movement of workers.
❖
Mobility of capital:
Depends on the type of capital goods.

Mobility of enterprise:
Depends on the mobility of entrepreneurs - enterprise is the most mobile factor of
production.

Quantity and quality of the factors of production

❖ Changes in the costs of factors of production - for example higher labour costs
caused by an increase in the national minimum wage would tend to reduce the
demand for labour.
❖ Government policies can affect the costs of production - through taxes and subsidies.
❖ New technologies allow firms to produce more output. Higher productivity also
enables firms to cut their average costs of production.
❖ Net migration of labour will affect the quantity of labour in the economy.
❖ Improvements in education and healthcare will improve the quality of labour as
workers become more valuable to firms. This helps to boost production.
❖ Unfavourable weather conditions will reduce the supply of agricultural products.
Conversely, good weather conditions will increase supply - increasing agricultural
output.

A country’s international competitiveness and economic growth are enhanced

by an occupationally and geographically mobile workforce.

The influence of opportunity cost on decision making:

Opportunity cost directly influences the decisions made by consumers, workers, producers
and governments. Scarce resources have competing uses, leading to an opportunity cost
when allocating them.
● Consumers have limited incomes - so whenever they purchase a particular good or
service, they give up the benefits of purchasing another product.

4
 Section 1 (Ch:1 - 4) Notes & Practice by Sana Ahmed

● Workers tend to specialise - giving up opportunities for other jobs and careers.
● Producers need to choose between competing business opportunities - research and
development.
● Governments constantly face decisions that involve opportunity cost. If a government
chooses to spend more money on improving the economy’s infrastructure (such as
transportation), it has less money available for other uses (such as
education/healthcare).

In general, decision makers will choose the option that gives them the greatest
economic return.

Opportunity cost is the

_________________________________________________________________________

_________________________________________________________________________.

What is the opportunity cost of working?

_________________________________________________________________________

_________________________________________________________________________

5
 Section 1 (Ch:1 - 4) Notes & Practice by Sana Ahmed

Production Possibility Curve

Main Concept: Production Possibility curve (PPC) shows the maximum combinations of
goods and services that can be produced by an economy in a given time period with its
limited resources.

There is an opportunity cost of using scarce resources.

PPC/PPF is a graphical representation showing all the possible options of output for two
products that can be produced using all factors of production, where the given resources are
fully and efficiently utilised per unit time.
Production Points (B,C,D,A)
show what is being produced
or what may be produced in
the future. These are optimal
production points.

Points inside the PPC (E)

means there is not full use of
resources. It is an
under-utilised point.

Points outside the PPC (F)

are currently unattainable
given the current state of
resources/technology.
PPC Assumptions
In drawing the production possibilities curve, we assume that

➔ the economy can produce only two goods

➔ that the quantities of factors of production and the technology available to the
economy are fixed
➔ the given resources are fully and efficiently utilised

Economic concepts:
Economists can use a PPC to illustrate a number of economic concepts including scarcity,
opportunity cost, productive efficiency, allocative efficiency, and economies of scale.
When an economy is operating on the PPF curve it is efficient.
It is not possible to produce more of one good without decreasing the amount produced for
the other good.
Likewise, if the economy is operating below the PPF curve, it is inefficient. In this case, the
economy can reallocate resources and produce more of both the goods.

Movements along a PPC:

A movement along a PPC shows that resources are being reallocated.It also shows the opportunity
cost of that decision.

6
 Section 1 (Ch:1 - 4) Notes & Practice by Sana Ahmed

Shifts of the PPC curve:

An entire curve can shift outwards or inwards.

An economy experiences economic growth when its potential productive increases due to
an increase in the quantity or quality of available factors of production, as shown by point B
in the illustration.

Conversely, economic decline occurs when there is a reduction in the quantity or quality of
available factors of production, as depicted by point A in the illustration.

Natural disasters can be a contributing factor to economic decline, as they can lead to a
reduction in available resources and, consequently, a decrease in the production of goods
and services. For example, natural disasters can damage infrastructure, deplete natural
resources, and reduce the availability of labour and capital, all of which can negatively
impact an economy's productive potential.

Changes in the quantity of resources can affect a country's production possibilities.

➔ For example, an increase in the quantity of labour due to the net immigration of
working-age people, a higher proportion of women entering the workforce, or an
increase in the retirement age can lead to an expansion in the production
possibilities.
➔ Similarly, the purchase of extra capital goods, known as net investment, increases
the quantity of capital goods and causes the PPC to shift rightwards.

7
 Section 1 (Ch:1 - 4) Notes & Practice by Sana Ahmed

Changes in the quality of resources can also affect a country's production

possibilities.

➔ Education and training improvements can enhance labour quality and raise
productivity, leading to a shift to the right in the PPC.
➔ Advancements in technology can improve the quality of capital goods, leading to a
rightward shift in the PPC.
➔ The quality of the enterprise can be raised through management training and
improved education, which can also result in a rightward shift in the PPC.

MCQ Practice

1. What is part of the economic definition of scarcity?

A high levels of taxation
B low levels of investment
C unequal distribution of income
D unlimited consumer wants

2. What is the cause of scarcity in an economy?

A high employment levels
B high investment levels
C unlimited resources
D unlimited wants

3. What does a point on a production possibility curve for an economy represent?

A economic growth is falling
B inefficient use of resources available
C maximum output possible with current technology
D total demand for goods and services

4. A country’s production possibility curve (PPC) moves from PPC1 to PPC2.

What could cause this movement in the PPC?

8
 Section 1 (Ch:1 - 4) Notes & Practice by Sana Ahmed

5. A government spends $100m on subsidising wind farm construction instead of

spending it on an increase in healthcare.
Which economic concept does this spending decision illustrate?
A external cost
B free goods
C market disequilibrium
D opportunity cost

Paper 2 - Practice Questions:

June 2016

Why can the economic problem never be solved? [2]

• Wants will grow more (1) than resources (1).
• Wants are infinite/unlimited (1) whilst resources are finite/limited (1).

What is meant by scarce resources? [2]

• Factors of production (1) that are limited in supply (1).

June 2017

Identify the two human factors of production. (2)

• Labour (1) entrepreneur/enterprise (1).

Explain two economic concepts shown by a production possibility curve diagram. (4)
1 mark each for each of two concepts identified:
• opportunity cost
• scarcity/economic problem/unlimited wants and limited resources
• choice
• efficiency/full employment
• specialisation
• economic growth/the difference between actual and potential economic growth

1 mark each for each of two explanations given:

• The curve shows that if more of one type of product is produced, less of another product
can be made
• The curve shows that there is a limit to the amount that can be produced with existing
resources/maximum output of two products
• The curve shows that more than one production point cannot be selected
• Any point on the curve is efficient/any point inside the curve is inefficient
• The curve shows the maximum amount of a product that can be produced if all resources
are devoted to one good
• Economic growth is shown by a shift to the right of the curve.

9
 Section 1 (Ch:1 - 4) Notes & Practice by Sana Ahmed

What is a possible opportunity cost of working?

Opportunity cost is the (next) best alternative forgone (1). Opportunity cost is leisure /
education / retirement / raising a family (1)

Analyse, using a production possibility curve diagram, how an increase in labour

productivity will affect an economy. (6)

Up to 4 marks for the diagram:

Axes correctly labelled (1).

Original production possibility curve / straight

downward sloping line drawn to the axes (1).

New PPC (1).

Indication of shift to the right – arrow or labelling (1).

Up to 2 marks for written explanation:

An increase in labour productivity increases the quality of labour (1) increases output per
worker hour / efficiency (1) increases productive potential / causes economic growth (1).

Name two factors of production used in making cars. 1 mark each for each of two
factors identified:
• car workers / labour
• car factory / capital
• car firm owner / entrepreneur
• water/land

June 2018

What may be the opportunity cost of building an airport? Opportunity cost is the (next)
best alternative foregone (1). Relevant example e.g. building a hospital (1).

Identify two examples of capital goods that may be used by a farm. One mark each for
each of two examples e.g. tractor, farm buildings.

Identify two factors of production involved in mining gold.

Any 2 from: Labour/miner (1) land / gold ore (1) capital/equipment (1) enterprise/owner (1)

June 2019

Define a capital good. A human-made good (1) used to produce other goods and services
(1).

10
 Section 1 (Ch:1 - 4) Notes & Practice by Sana Ahmed

Analyse, using a production possibility curve (PPC) diagram, the effect of damaging
weather on an economy.

Up to 4 marks for the diagram:

• axes correctly labelled in terms of two different products
or types of products (1)
• initial curve or downward sloping line is drawn to the
axes (1)
• second curve or downward sloping line is drawn to the
axes (1)
• An indication either by labelling or an arrow that the
curve has shifted inwards / left (1)

Up to 2 marks for written analysis:

Bad weather will reduce the quantity of resources (1). The amount that can be produced with
fewer resources will fall (1).

Nov 2019

Identify two examples of land used in growing agricultural crops. • soil • water • natural
fertiliser • seeds • weather

State two key questions about how resources are allocated.

One mark each for two from: What to produce, how to produce it, for whom / who gets what
is produced.

Define wages. A payment/reward (1) to labour/workers (1).

June 2021

Identify two basic necessities, other than housing. Two from e.g.: Food, water, clothing,
healthcare and education.

Define enterprise. Risk bearing (1) setting up / owning a business (1) key decision making /
organisation of the other factors of production (1) profit incentive / profit is the reward (1).

Explain the influence of opportunity cost on consumers’ decisions.

Opportunity cost is the (next) best alternative (1) forgone / sacrificed (1).
Consumers have limited income / time (1) have to make choices (1) cannot have everything
they want (1) if they buy more of one product may have to buy less of another / example of
what product may be given up to buy another product (1).

11