This chapter is an introduction to the study of economics.

It is also an
introduction to many topics that will be explored in depth in later
chapters.

Scarcity, choice and opportunity cost

The fundamental problem of economics: scarcity and choice

The problem of scarcity

Explain that scarcity exists because factors of production are fi nite and
wants are infi nite.

The term ‘economics’ is derived from the ancient Greek expression oı

′kov vε′µεiv (oikon nemein), which originally meant ‘one who manages
and administers all matters relating to a household’. Over time, this
expression evolved to mean ‘one who is prudent in the use of resources’.
By extension, economics has come to refer to the careful management of
society’s scarce resources to avoid waste. Let’s examine this idea more
carefully. Human beings have very many needs and wants. Some of these
are satisfi ed by physical objects and others by non-physical activities. All
the physical objects people need and want are called goods (food,
clothing, houses, books, computers, cars, televisions, refrigerators, and
so on); the non-physical activities are called services (education, health
care, entertainment, travel, banking, insurance and many more). The
study of economics arises because people’s needs and wants are
unlimited, or infi nite. Whereas some individuals may be satisfi ed with
the goods and services they have or can buy, most would prefer to have
more. They would like to have more and better computers, cars,
educational services, transport services, housing, recreation, travel, and
so on; the list is endless.

Yet it is not possible for societies and the people within them to produce
or buy all the things they want. Why is this so? It is because there are not
enough resources. Resources are the inputs used to produce goods and
services wanted by people, and for this reason are also known as factors
of production. They include things like human labour, machines and
factories, and ‘gifts of nature’ like agricultural land and metals inside the
earth. Factors of production do not exist in unlimited abundance: they
are scarce, or limited and insuffi cient in relation to unlimited uses that
people have for them. Scarcity is a very important concept in economics.
It arises whenever there is not enough of something in relation to the
need for it. For example, we could say that food is scarce in poor
countries, or we could say that clean air is scarce in a polluted city. In
economics, scarcity is especially important in describing a situation of
insuffi cient factors of production, because this in turn leads to insuffi
cient goods and services. Defi ning scarcity, we can therefore say that:

Scarcity is the situation in which available resources, or factors of

production, are fi nite, whereas wants are infi nite. There are not enough
resources to produce everything that human beings need and want.

Why scarcity forces choices to be made

Explain that as a result of scarcity, choices have to be made.

The confl ict between unlimited wants and scarce resources has an
important consequence. Since

people cannot have everything they want, they must make choices. The
classic example of a choice forced on society by resource scarcity is that
of ‘guns or butter’, or more realistically the choice between producing
defence goods (guns, weapons, tanks) or food: more defence goods mean
less food, while more food means fewer defence goods. Societies must
choose how much of each they want to have. Note that if there were no
resource scarcity, a choice would not be necessary, since society could
produce as much of each as was desired. But resource scarcity forces the
society to make a choice between available alternatives. Economics is
therefore a study of choices. The confl ict between unlimited needs and
wants, and scarce resources has a second important consequence. Since
resources are scarce, it is important to avoid waste in how they are used.
If resources are not used effectively and are wasted, they will end up
producing less; or they may end up producing goods and services that
people do not really want or need. Economics must try to fi nd how best
to use scarce resources so that waste can be avoided. Defi ning
economics, we can therefore say that:

Economics is the study of choices leading to the best possible use of

scarce resources in order to best satisfy unlimited human needs and
wants.

As you can see from this defi nition of economics, economists study the
world from a social perspective, with the objective of determining what is
in society’s best interests.

Test your understanding 1.1 1 Think of some of your most important

needs and wants, and then explain whether these are satisfi ed by goods
or by services. 2 Why is economics a study of choices? 3 Explain the
relationship between scarcity and the need to avoid waste in the use of
resources. 4 Explain why diamonds are far more expensive than water,
even though diamonds are a luxury while water is a necessity without
which we cannot live.

Test your understanding 1.1

Think of some of your most important needs and wants, and then explain
whether these are satisfi ed by goods or by services.

Explain that the three basic economic questions that must be answered
by any economic system are: ‘What to produce?’, ‘How to produce?’ and
‘For whom to produce?’ Explain that economics studies the ways in which
resources are allocated to meet needs and wants.

Scarcity forces every economy in the world, regardless of its form of

organisation, to answer three basic questions:

What to produce. All economies must choose what particular goods and
services and what quantities of these they wish to produce. How to
produce. All economies must make choices on how to use their resources
in order to produce goods and services. Goods and services can be
produced by use of different combinations of factors of production (for
example, relatively more human labour with fewer machines, or relatively
more machines with less labour), by using different skill levels of labour,
and by using different technologies. For whom to produce. All economies
must make choices about how the goods and services produced are to be
distributed among the population. Should everyone get an equal amount
of these? Should some people get more than others? Should some goods
and services (such as education and health care services) be distributed
more equally?

The fi rst two of these questions, what to produce and how to produce,
are about resource allocation, while the third, for whom to produce, is
about the distribution of output and income.

Resource allocation refers to assigning available resources, or factors of

production, to specifi c uses chosen among many possible alternatives,
and involves answering the what to produce and how to produce
questions. For example, if a what to produce choice involves choosing a
certain amount of food and a certain amount of weapons, this means a
decision is made to allocate some resources to the production of food and
some to the production of weapons. At the same time, a choice must be
made about how to produce: which particular factors of production and
in what quantities (for example, how much labour, how many machines,
what types of machines, etc.) should be assigned to produce food, and
which and how many to produce weapons.

If a decision is made to change the amounts of goods produced, such as

more food and fewer weapons, this involves a reallocation of resources.
Sometimes, societies produce the ‘wrong’ amounts of goods and services
relative to what is socially desirable. For example, if too many weapons
are being produced, we say there is an overallocation of resources in
production of weapons. If too few socially desirable goods or services are
being produced, such as education or health care, we say there is an
underallocation of resources to the production of these.

The third basic economic question, for whom to produce, involves the
distribution of output and is concerned with how much output different
individuals or different groups in the population receive. This question is
also concerned with the distribution of income among individuals and
groups in a population, since the amount of output people can get
depends on how much of it they can buy, which in turn depends on the
amount of income they have. When the distribution of income or output
changes so that different social groups now receive more, or less, income
and output than previously, this is referred to as redistribution of income.

Plot a supply curve from a linear function (e.g. Qs = –30 + 20P).

If we are given a supply function specifying the numerical values of c and

d, we can make a schedule of the relation described by the equation and
use this information to plot a graph of the curve. We are given the supply
function:

Qs = 2 + 2P

where Qs = quantity of chocolate bars supplied per week, in thousands

(the dependent variable) P = price of chocolate bars, in $ (the
independent variable) 2 = the Q-intercept (horizontal intercept) 2 = slope
(given by ∆Qs/∆P).

Setting P equal to various values, and solving for Qs, we obtain a series
of P and Qs combinations, giving us the supply schedule. If we begin with
P = 0, we fi nd the Q-intercept, which is Qs = 2 (thousand); then P = 1
gives Qs = 2 + 2(1) = 4 (thousand); P = 2 gives Qs = 2 + 2(2) = 6
(thousand), and so on. The various price–quantity combinations are
shown in Table 2.5.

We then use this information to plot the supply curve, shown in Figure
2.14. Note that this is the same supply curve that appears in Figure
2.6(c) (page 27). The axes must be labelled correctly, with P in $ on the
vertical axis and Q in thousands on the horizontal axis. The supply curve
consists of a series of points: (2,0), (4,1), (6,2), (8,3), and so on.2 Since
the supply curve is linear, it is only necessary to fi nd two points, and
then draw the supply curve (though it may be a good idea to fi nd a third
point to be sure that the calculations have been done correctly; you need
to be sure that a straight line can be drawn through the three points).

We then use this information to plot the supply curve, shown in Figure
2.14. Note that this is the same supply curve that appears in Figure
2.6(c) (page 27). The axes must be labelled correctly, with P in $ on the
vertical axis and Q in thousands on the horizontal axis. The supply curve
consists of a series of points: (2,0), (4,1), (6,2), (8,3), and so on.2 Since
the supply curve is linear, it is only necessary to fi nd two points, and
then draw the supply curve (though it may be a good idea to fi nd a third
point to be sure that the calculations have been done correctly; you need
to be sure that a straight line can be drawn through the three points).