The nature of the basic economic problem

Economics · The basic economic problem. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

Every person, firm and government wants more than it can have. Wants are unlimited, but the resources used to satisfy them (land, labour, capital and enterprise) are limited. This gap is called scarcity, and it is the basic economic problem. It exists in rich countries as well as poor ones, because wants keep growing.

Scarcity forces choice. A consumer has limited income, a worker has limited time, a firm has limited funds and a government has limited tax revenue. Every economy must therefore answer three questions: what to produce, how to produce it and for whom to produce it.

A good that needs scarce resources is an economic good. A free good needs none.

Rules to remember

Basic economic problem: resources are finite but wants are unlimited
Scarcity: there are not enough resources to produce everything people want
What to produce: which goods and services, and how much of each
How to produce: which mix of resources and methods to use, for example more machines or more workers
For whom to produce: who receives the goods and services that are made
Economic good: uses scarce resources, so it has an opportunity cost
Free good: is not scarce and has no opportunity cost, for example sunlight or air

Common mistake

Students say that a free good is one with a zero price. A good given away without charge, such as state schooling, still uses scarce resources, so it is an economic good.

Worked example

A bakery with one oven decides to bake bread instead of cakes. It then decides to mix the dough by machine instead of hiring more workers. Which basic economic questions has it answered, in order?

The oven is a limited resource, so the bakery cannot make everything it would like: this is scarcity.
Choosing bread instead of cakes is a choice about which good to make.
Choosing a machine instead of extra workers is a choice about the method and the mix of resources.

Answer: First what to produce, then how to produce.

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