The Problem of Choice (DP IB Economics)
Revision Note
The Factors of Production
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
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Some of the Factors of Production Required to Produce a Motor Car
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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: Scarcity
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
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Opportunity Cost Defined
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)
Opportunity Cost in Decision Making
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
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Examiner Tip
Opportunity cost is about the loss of the next best alternative. It is not a monetary amount. Money may well be a factor but opportunity cost is about the loss of the next best choice when making a decision.
Economic Goods & Free Goods
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
Economic Systems
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
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?
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?
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
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