Revision:The Economic Problem

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The economic problem arises due to scarcity. People have unlimited wants but there are insufficient resources to provide these goods and services. People must therefore make choices, and if they act rationally, they choose the choice which provides the lowest opportunity cost. The opportunity cost is defined as the value of the next best alternative forgone.

For example: Someone makes a rational choice about going on a holiday. Even if the holiday is a disaster (e.g. the hotel is half finished) they have still made the rational choice by acting on the information they had when booking the holiday.

Money is no solution to the economic problem. It simply provides the means of rationing or allocating goods between consumers.

Opportunity cost

Opportunity cost is the next best alternative which people lose when they take their first choice. This is usually expressed in terms of the goods which you gave up rather than in terms of money. Opportunity is the real cost of the product. The basis of choice gives a good its price and changes it from a free good to an economic good.

The economic units

There are three economic units which are found in every society and engaged in making economic choices.

1. The household - the consumptive unit. The household must consider their limited income and their wants as distinct from their needs when making choices. A need is something essential to man's survival; anything else qualifies as a want. Wants must be translated into effective demand before they have any effect on the economy.
2. The firm - the productive unit. The organisation involved in the production of wealth and in our economy it is motivated by the consideration of profit. The business or the firm is responsible for the production of wealth and the creation of all the goods and services which we want as individuals.
3. The government - the role of government varies depending on the views of those currently elected. Left wing governments believe in greater government intervention than right wing governments.

Production possibility curves

Production possibility curves/production possibility frontiers (PPF) show the different amounts of 2 goods that can be produced with a fixed amount of resources. Points on the PPF itself produce the same level of welfare. This occurs when all resources are fully utilised. Points inside the curve are wasteful, perhaps due to unemployment or idle factories. Points outside the PPF are unobtainable unless the PPF itself shifts outwards due to growth (an increase in resources available, better efficiency, or new technology).

PPFs can be used to show opportunity cost. A move from A to B on the curve (see diagram) increasing the quantity of consumer goods has an opportunity cost of the drop in capital goods.

PPFs curve usually shift outwards because of the law of diminishing returns. The extra output from an increase in resource allocation decreases.

Also See

Take a look at the other unit 1 A level economics revision notes:

• The Economic Problem (AQA, Edex, OCR, WJEC)
• Factors of production (AQA, OCR)
• Positive and normative economics (AQA)
• Specialisation and Trade (AQA, Edex, OCR, WJEC)
• Producer and consumer surplus (AQA, Edex, OCR, WJEC)
• Demand theory (AQA, Edex, OCR, WJEC)
• Supply theory (AQA, Edex, OCR, WJEC)
• Supply and Demand Equilibrium (AQA, Edex, OCR, WJEC)
• Elasticity of demand (AQA, Edex, OCR, WJEC)
• Elasticity of supply (AQA, Edex, OCR, WJEC)
• The Price Mechanism (AQA, Edex)
• Indirect Taxes and Subsidies (Edex)
• The labour market (Edex)
• Economies of scale (AQA)
• Allocative efficiency (OCR)

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