1.1.2 The Problem of Choice

• Factors of production are the resources used to produce goods and services
  • Land, labour, capital and enterprise
    
    
• The production of any good/service requires the use of a combination of all four factors of production
  • Goods are physical objects that can be touched (tangible) e.g. mobile phone
  • Services are actions or activities that one person performs for another (intangible) e.g manicure, car wash
     

The Four Factors of Production

Some of the Factors of Production Required to Produce a Motor Car

• In a free market economic system, the factors of production are privately owned by households or firms
  • Households make these resources available to firms who use them to produce goods/services
  •  Firms purchase land, labour, and capital from households in factor markets
     
• Households receive the following financial rewards for selling their factors of production. This reward is called factor income
  • The factor income for land → rent
  • The factor income for labour → wages
  • The factor income for capital → interest
  • The factor income for entrepreneurship → profit

• The basic economic problem is that resources are scarce
  • In economics, these resources are called the factors of production
    
    
• There are finite resources available in relation to the infinite wants and needs that humans have
  • Needs are essential to human life e.g. shelter, food, clothing
  • Wants are non-essential desires e.g. better housing, a yacht etc.
    
    
• Due to the problem of scarcity, choices have to be made by producers, consumers, workers and governments about the best (most efficient) use of these resources
  
  
• Economics is the study of scarcity and its implications for resource allocation in society
   

All Stakeholders in an Economy face the Basic Economic Problem

• Opportunity cost is the loss of the next best alternative when making a decision
  
  
• Due to the problem of scarcity, choices have to be made about how to best allocate limited resources amongst competing wants and needs
  
  
• There is an opportunity cost in the allocation of resources
  • E.g. When a consumer chooses to purchase a new phone, they may be unable to purchase new jeans. The jeans represent the loss of the next best alternative (the opportunity cost)
    

• An understanding of opportunity cost may change many decisions made by consumers, workers, firms and governments
• Factoring the opportunity cost into a decision often results in different outcomes and so a different allocation of resources

Examples of how the Consideration of Opportunity Costs can Change Decisions

• Economic goods are scarce in relation to the demand for them
  • This makes them valuable
  • Due to their value, producers will attempt to supply them in order to make a profit
  • Anything that has a price tag on it is an economic good e.g. oil, corn, gold, trainers, watches and bicycles
    
    
• Free goods are abundant in supply
  • Due to this abundance, it is not possible to make a profit from supplying free goods
  • Drinking water has been a free good for thousands of years, but as the population increases and water sources become more polluted, it has become an economic good
  • E.g. sunlight, the air we breathe, sea water

• In order to solve the basic economic problem of scarcity, economic systems emerge or are created by different economic agents within the economy
  
  • These agents include consumers, producers, the government, and special interest groups (e.g. environmental pressure groups or trade unions)
  • Any economic system aims to allocate the scarce factors of production
     
• The three main economic systems are a free market system, mixed economy, and planned economy
  
  

What determines the economic system of a country? 
  

How the three questions are answered determines the economic system of a country
 

• Each economy has to answer three important economic questions

1. What to produce? As resources are limited in supply, decisions carry an opportunity cost. Which goods/services should be produced e.g. better rail services or more public hospitals?
   
   
2. How to produce it? Would it be better for the economy to have labour-intensive production so that more people are employed, or should goods/services be produced using machinery?
   
   
3. Who to produce it for? Should goods/services only be made available to those who can afford them, or should they be freely available to all?

  
How These Questions are Answered Determines the Economic System