“Economics is the social science that describes the factors that

determine the production, distribution and consumption of goods and

services.”
(Source: Wikipedia)

The Nature of the Economic Problem

Resources: are the inputs required for the production of goods and
services.
Scarcity: a lack of something (in this context, resources).
The fundamental economic problem is that there is a scarcity of
resources to satisfy all human wants and needs. There are finite
resources and unlimited wants. This is applicable to consumers,
producers, workers and the government, in how they manage their
resources.

Economic goods are those which are scarce in supply and so can only
be produced with an economic cost and/or consumed with a price. In
other words, an economic good is a good with an opportunity cost. All the
goods we buy are economic goods, from bottled water to clothes.
Free goods, on the other hand, are those which are abundant in supply,
usually referring to natural sources such as air and sunlight.
The Factors of Production
Resources are also called ‘factors of production’ (especially in Business).
They are:

 Land: all natural resources in an economy. This includes the

surface of the earth, lakes, rivers, forests, mineral deposits, climate
etc.
 The reward for land is the rent it receives.
 Since, the amount of land in existence stays the same,
its supply is said to be fixed. But in relation to a country
or business, when it takes over or expands to a new area,
you can say that the supply of land has increased, but the
supply is not depended on its price, i.e. rent.
 The quality of land depends upon the soil type, fertility,
weather and so on.
 Since land can’t be moved around, it is geographically
immobile but since it can be used for a variety of
economic activities it is occupationally mobile.
 Labour: all the human resources available in an economy. That
is, the mental and physical efforts and skills of workers/labourers.
 The reward for work is wages/salaries.
 The supply of labour depends upon the number of workers
available (which is in turn influenced by population size, no.
of years of schooling, retirement age, age structure of the
 population, attitude towards women working etc.) and the
number of hours they work (which is influenced by number
of hours to work in a single day/week, number of holidays,
length of sick leaves, maternity/paternity leaves, whether
the job is part-time or full-time etc.).
 The quality of labour will depend upon the skills, education
and qualification of labour.
 Labour mobility can depend up on various factors. Labour
can achieve high occupational mobility (ability to change
jobs) if they have the right skills and qualifications. It can
achieve geographical mobility (ability to move to a place
for a job) depending on transport facilities and costs,
housing facilities and costs, family and personal priorities,
regional or national laws and regulations on travel and
work etc.
 Capital: all the man-made resources available in an economy. All
man-made goods (which help to produce other goods – capital
goods) from a simple spade to a complex car assembly plant are
included in this. Capital is usually denoted in monetary terms as the
total value of all the capital goods needed in production.
 The reward for capital is the interest it receives.
 The supply of capital depends upon the demand for goods
and services, how well businesses are doing, and savings in
the economy (since capital for investment is financed by
loans from banks which are sourced from savings).
 The quality of capital depends on how many good quality
products can be produced using the given capital. For
example, the capital is said to be of much more quality in a
car manufacturing plant that uses mechanisation and
technology to produce cars rather than one in which
manual labour does the work.
 Capital mobility can depend upon the nature and use of
the capital. For example, an office building is
geographically immobile but occupationally mobile. On the
other hand, a pen is geographically and occupationally
mobile.
 Enterprise: the ability to take risks and run a business
venture or a firm is called enterprise. A person who has enterprise
is called an entrepreneur. In short, they are the people who start a
business. Entrepreneurs organize all the other factors of production
and take the risks and decisions necessary to make a firm run
successfully.
 The reward to enterprise is the profit generated from the
business.
 The supply of enterprise is dependent on entrepreneurial
skills (risk-taking, innovation, effective communication
etc.), education, corporate taxes (if taxes on profits are too
high, nobody will want to start a business), regulations in
doing business and so on.
  The quality of enterprise will depend on how well it is able
to satisfy and expand demand in the economy in cost-
effective and innovative ways.
 Enterprise is usually highly mobile, both geographically and
occupationally.
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All the above factors of productions are scarce because the time people
have to spend working, the different skills they have, the land on which
firms operate, the natural resources they use etc. are all in limited in
supply; which brings us to the topic of opportunity cost.

Opportunity Cost
The scarcity of resources means that there are not sufficient goods and
services to satisfy all our needs and wants; we are forced to choose some
over the others. Choice is necessary because these resources have
alternative uses- they can be used to produce many things. But since
there are only a finite number of resources, we have to choose.

When we choose something over the other, the choice that was given up
is called the opportunity cost. Opportunity cost, by definition, is the
next best alternative that is sacrificed/forgone in order to satisfy
the other.
Example 1: the government has a certain amount of money and it has two
options: to build a school or a hospital, with that money. The govt. decides
to build the hospital. The school, then, becomes the opportunity cost as it
was given up. In a wider perspective, the opportunity cost is the education
the children could have received, as it is the actual cost to the economy of
giving up the school.
Example 2: you have to decide whether to stay up and study or go to bed
and not study. If you chose to go to bed, the knowledge and preparation
you could have gained by choosing to stay up and study is the opportunity
cost.
Production Possibility Curve Diagrams
(PPC)
Because resources are scarce and have alternative uses, a decision to
devote more resources to producing one product means fewer resources
are available to produce other goods. A Production Possibility Curve
diagram shows this, that is, the maximum combination of two goods
that can be produced by an economy with all the available
resources.
The PPC diagram above shows the production capacities of two goods- X
and Y- against each other. When 500 units of good X are produced, 1000
units of good Y can be produced. But when the units of good X increases
to 1000, only 500 units good Y can be produced.

Let’s look at the PPC named A. At point X and Y it can produce certain
combinations of good X and good Y. These are points on the curve- they
are attainable, given the resources. Th economy can move between
points on a PPC simply by reallocating resources between the two goods.
If the economy were producing at point Z, which is inside/below the PPC,
the economy is said to be inefficient, because it is producing less than
what it can.
Point W, outside/above the PPC, is unattainable because it is beyond the
scope of the economy’s existing resources. In order to produce at point W,
the economy would need to see a shift in the PPC towards the right.
For an outward shift to occur, an economy would need to:
 discover or develop new raw materials. Example: discover new oil
fields
 employ new technology and production methods to increase
productivity
 increase labour force by encouraging birth and immigration,
increasing retirement age etc.
An outward shift in PPC, that is higher production possibility, will lead to
economic growth.

In the same way, an inward shift can occur in the PPC due to:
 natural disasters, that erode infrastructure and kill the population
 very low investment in new technologies will cause productivity to
fall over time
  running out of resources, especially non-renewable ones like oil or
water
An inward shift in the PPC will lead to the economy shrinking.

How is opportunity cost linked to PPC?

Individuals, businessmen and the government can calculate
the opportunity cost from PPC diagrams. In the above example, if the
firm decided to increase production of good Y from 500 to 750, it can
calculate the opportunity cost of the decision to be 250 units of good X
(as production of good X falls from 1000 to 750). They are able to
compare the opportunity cost for different decisions.

The concept of opportunity cost is relevant to all decision-makers, not just governments.

Individuals: People face opportunity costs daily. For example, a student choosing to study
instead of going out incurs the cost of socializing, demonstrating personal trade-offs in
decision-making.

Businesses: Companies also deal with opportunity costs when allocating resources. For
instance, a business may choose to invest in new equipment rather than expanding its
workforce, thereby forgoing the benefits of the alternative option.

Governments: While governments encounter opportunity costs in policy-making, such as

deciding between funding healthcare or education, this does not imply exclusivity. Their
decisions reflect the same trade-offs faced by individuals and businesses.

Conclusion: Opportunity cost is a universal concept that applies across all sectors.
Recognizing opportunity costs aids in making informed choices, underscoring its importance
beyond government decisions.