Edexcel A-Level Economics · Revision notes

1.1.3 The Economic Problem

Every economic question starts from the same place: people want more than can be produced. This gap between what is wanted and what is available is the economic problem, and the rest of the subject is about how societies deal with it.

Scarcity: unlimited wants, finite resources

Scarcity exists because human wants are effectively unlimited while the resources available to satisfy them are finite.

• Wants are unlimited. As incomes rise, people do not stop wanting things; they want better versions, new products and more services. There is no point at which a whole society runs out of wants.
• Resources are finite. The land, labour, capital and enterprise available to produce goods and services are limited at any moment in time.

Key distinction: Scarcity is not the same as poverty or shortage. A wealthy country still faces scarcity, because it still cannot produce everything its population would like. A shortage is a temporary situation in one market; scarcity is permanent and universal.

Because resources are scarce, every society must answer three questions:

1. What to produce, and in what quantities?
2. How to produce it, with which combination of resources and technology?
3. For whom to produce, and how output is distributed between people?

Different economic systems answer these questions in different ways, through markets, the state, or a mix of both.

Renewable and non-renewable resources

Resources differ in whether using them today reduces what is available in the future.

• Renewable resources can be replenished naturally over time. Examples include solar and wind energy, forests and fish stocks. Some, such as sunlight, cannot be used up at all. Others, such as forests and fisheries, are only renewable if they are used no faster than they regenerate. Overfishing can turn a renewable stock into a depleted one.
• Non-renewable resources exist in a fixed stock and cannot be replaced once used. Examples include oil, natural gas, coal and many minerals.

The distinction matters because using non-renewable resources today has an opportunity cost borne by future generations. It is also central to debates about sustainable growth and climate change.

Opportunity cost

Opportunity cost is the value of the next best alternative forgone when a choice is made. Because resources are scarce, choosing one thing always means giving up something else.

It matters to every economic agent.

Consumers A student with £30 who buys a concert ticket gives up whatever else the money would have bought. Time has an opportunity cost too: an evening revising is an evening not spent earning from a part-time job.

Producers A farmer who plants wheat on a field cannot use the same field for barley. A firm that invests in new machinery gives up the return it could have earned by using the funds elsewhere. Firms comparing projects are comparing opportunity costs.

Government Government faces the starkest trade-offs because its spending is so large. Money spent on defence cannot also be spent on the NHS or schools. Cutting taxes means less revenue for public services, or more borrowing that must be repaid later.

Watch out: Opportunity cost is measured by the next best alternative only, not by everything that could have been done instead. It also need not be measured in money: it is the value of the alternative, whatever form that takes.

Why the economic problem matters

Scarcity is the reason economics exists as a subject.

• Because resources are scarce, they must be allocated.
• Because they must be allocated, choices are made.
• Because choices are made, there are opportunity costs.

This chain runs through everything that follows: how markets allocate resources through prices, why governments intervene, and why economic growth matters. Growth pushes back the limits of scarcity without ever removing them.

Key terms

Common mistakes

• Treating scarcity as shortage. Scarcity is permanent and applies everywhere. A shortage is temporary and applies to one market.
• Listing every alternative as the opportunity cost. Only the next best alternative counts.
• Assuming renewable means unlimited. Fish stocks and forests are renewable only if harvested sustainably.
• Assuming opportunity cost is always a money amount. It is the value of the alternative forgone, which may be time, output or wellbeing.
• Forgetting government faces opportunity costs. Public spending is still a choice between alternatives, even when it is described as "free" to users.

How this has been examined

This topic has not appeared as a standalone question in the Edexcel papers indexed on this site.

That is not a reason to skip it. Scarcity and opportunity cost underpin almost every other topic, and opportunity cost is the idea that production possibility frontiers and comparative advantage are built on.

Where this goes next

The production possibility frontier in 1.1.4 Production possibility frontiers turns scarcity and opportunity cost into a diagram. 1.1.6 Free market economies, mixed economy and command economy looks at the different ways societies answer what, how and for whom. 1.2.1 Rational decision making examines how consumers and firms make choices under scarcity, and the environmental cost of using resources reappears in 1.3.2 Externalities.