SECTION 1

The basic
economic
problem
LESSON 1 The nature of the economic
problem

The nature of the economic problem: fi nite resources and

individuals or households

firms (businesses which operate in

the government.
 The three basic economic
questions addressed by
economic agents are:
1. hat to produce?
2. How to produce it?
3. For whom to produce it?
 Goods are physical items that can be produced, bought and
sold. Examples are furniture, clothing, toothpaste and pencils.
Services are non-physical items that can be provided by fi rms
and paid for by customers. Examples are haircuts, bus journeys,
education, concerts, telephone calls and internet access.
 Needs are the essential goods and services required for human
survival. These include nutritional food, clean water, shelter,
protection, clothing and access to healthcare and education.
 Wants are goods and services that are not necessary for
survival but are human desires — that is, things we would like
to have. Wants are unlimited as most people are rarely satisfi
ed with what they have and are always striving for more. Wants
are a matter of personal choice and part of human nature.
Economic goods and free goods
 An economic good is one which is limited in supply, such as
oil, wheat, cotton, housing and cars. It is scarce in relation to
the demand for the product, so human effort is required to
obtain an economic good.
 Free goods are unlimited in supply, such as the air, sea, rain
water, sunlight and (to some extent) public domain webpages.
There is no opportunity cost in the production or consumption
of free goods.
 An example of ‘free goods’
CLASS ACTIVITY HAVING 1 MARKS OF EACH MCQS
 1 The basic economic problem is
 A how to allocate scarce resources to satisfy unlimited needs
and wants.
 B how to satisfy limited wants and needs with unlimited
resources.
 C meeting increased demand for goods and services with
limited resources.
 D the interaction of market forces to satisfy unlimited needs
and wants.
 2 An example of a free good is
 A housing.
 B public domain web pages.
 C running shoes.
 3 An olive farm in northern Italy produces organic olive oil
which it sells on its website to specialist shops around the
world. An example of tertiary industry activity is
 A bottling the olive oil.
 B crushing the olives to extract the oil.
 C growing olive trees.
 D selling the oil over the internet.
 4 Which is not one of the three basic economic questions
addressed by an economy?
 A For whom should production take place?
 B How should production take place?
 C What production should take place?
 D When should production take place?
 Define the term public sector. [2 marks]
 Using relevant examples, explain the difference between needs
and wants. [4 marks]
 Explain the difference between economic goods and free
goods. [4 marks]
LESSOON 2 The factors of production

Definition
 The factors of production refer to the resources required to
produce a good or service, namely land, labour, capital and
enterprise.
Factors of production
 Production of any good or service requires resources, known as the factors
of production, which are divided into four categories:
 Land the natural resources required in the production process, such as oil,
coal, water, wood, metal ores and agricultural products.
 Labour the human resources required in the production process, including
skilled and unskilled labour.
 Capital the manufactured resources required in the production process,
such as machinery, tools, equipment and vehicles.
 Enterprise the skills a business person requires to combine and manage
the other three factors of production successfully.
Factors of production: land, labour,
enterprise and capital
Rewards for factors of production
 As the factors of production are productive resources, each has a reward for
its use in the production process:
1. The reward for land is called rent. Rental income comes from the
ownership of property, such as physical and related assets, and is paid by
the tenants of the land resources.
2. The reward for labour is called wages and salaries. Wages are paid to
workers on an hourly basis, such as those who earn a national minimum
wage (see Chapter 18).
3. The reward for capital is called interest. If the interest rate (see Chapter
27) is high, it becomes less worthwhile for businesses and households to
borrow money for production purposes because the cost of borrowing is
high, and vice versa.
4. The reward for enterprise is called profit. This is the return for the
entrepreneur’s good business ideas and for taking the risks in starting up
and running the organisation. Profi t is what remains after all business costs
are paid, including payment to the other factors of production.
The mobility of factors of production
 The mobility of factors of production refers to the extent to
which resources can be changed for one another in the
production process. For example, farming can be very
traditional in some parts of the world and rely heavily on labour
resources. Economists usually talk about labour mobility,
although factor mobility can apply to any factor of production.
For example:
 Land might be used for various competing purposes, such as to
grow certain fruits and/or vegetables, or to construct buildings
such as housing, hospitals or schools.
 Capital equipment might be used for different purposes too. For
example, the same machinery in the Coca-Cola factory can be
used to produce Coca-Cola, Sprite and/or Fanta.
 Entrepreneurs can also be mobile. For example, Meg Whitman,
chief executive offi cer (CEO) of Hewlett-Packard, was
previously a vice president of the Walt Disney Company and
CEO of eBay.
Geographical mobility
 Geographical mobility refers to the willingness and ability of
a person to relocate from one area to another for employment
purposes. Some people may not be geographically mobile for
the following reasons:
 Family ties and related commitments — people may not
want to relocate as they want to be near their family and
friends.
 Costs of living — the costs of living vary between regions and
countries, so may be too high in another location, making it
uneconomical for a person to relocate. For example, a bus
driver may fi nd it impossible to relocate from the countryside
to the city because house prices are much higher in the city
and he or she therefore cannot afford to purchase a home in
the city.
Occupational mobility
 Occupational mobility refers to the ease with which a person
is able to change between jobs. The degree of occupational
mobility depends on the cost and length of training required to
change profession. Developing and training employees to
improve their skills set improves labour occupational mobility
(as workers can perform a greater range of jobs).
 Generally, the more occupationally and geographically mobile
workers are in a country, the greater its international
competitiveness and economic growth are likely to be.
Causes of changes in the quantity and quality of factors of
production
 The quantity and quality of factors of production will change if
there is a change in the demand for and/or supply of land,
labour, capital or enterprise. Possible changes include the
following:
 Changes in the costs of factors of production — for example,
higher labour costs caused by an increase in the national
minimum wage would tend to reduce the demand for labour.
 Government policies can affect the costs of production, such as
through the use of taxes and subsidies (see Chapter 15). For
example, lower income taxes can help to create incentives to
work, thus increasing the quantity of labour resources.
CLASS ACTIVITY HAVING 1 MARKS OF EACH MCQS
 1 Production of any good or service requires resources known as
 A factors of production.
 B land.
 C production facilities.
 D raw materials.
 2 What is the generic name for the natural resources required in the
production process?
 A capital
 B enterprise
 C labour
 D land
 With the use of a relevant example, describe the meaning of
land as a factor of production. [2 marks]
 7 Explain two causes of changes in the quantity and quality of
factors of production. [4 marks
LESSON 3 Opportunity cost

Opportunity cost
 Opportunity cost is a very important concept in the study of
economics. Opportunity cost is the cost of the next best
opportunity forgone (given up) when making economic
decisions. Every choice made has an opportunity cost because
in most cases there is an alternative.
 Some examples of opportunity cost are as follows:
1. The opportunity cost of choosing to study IGCSE Economics is
another IGCSE subject you could be studying instead.
2. The opportunity cost of visiting the cinema on Saturday night
could be the money you would have earned from babysitting
for your neighbour instead of going to the cinema.
3. The opportunity cost of building an additional airport terminal
is using the same government funds to build public housing for
low-income families
The influence of opportunity cost on decision making
 Opportunity cost directly influences the decisions made by
consumers, workers, producers and governments. Referring to
the basic economic problem (see Chapter 1), there are
competing uses for the economy’s scarce resources. Thus,
there is an opportunity cost when allocating scarce resources.
 Consumers have limited incomes, so whenever they purchase a
particular good or service, they give up the benefits of
purchasing another product.
 Workers tend to specialise (see Chapter 18) — for example, as
secondary school teachers, accountants, doctors and lawyers.
By choosing to specialise in a particular profession, workers
give up the opportunity to pursue other jobs and careers.
CLASS ACTIVITYS HAVING 1 MARKS OF EACH MCQS
 1 Why does almost every economic choice made have an opportunity cost?
 A In most cases, there is an alternative option.
 B In most cases, there is no alternative option.
 C People have infinite wants.
 D Resources are not allocated efficiently.
 2 Which is least likely to be an opportunity cost of studying economics at
university?
 A other things the money could be spent on instead of going to university
 B the difference in earning potential by attending university
 C the option to study geography at university
 D the option to work
 Define the term opportunity cost. [2 marks]
 Explain the opportunity cost to society of constructing a new
airport. [4 marks]
 Colleen earns $10.50 an hour, but has chosen to take 2 hours
off work in order to attend a school trip with her son to a
theatre show. Her ticket costs $15. Calculate the opportunity
cost of Colleen attending this school trip. [2 marks]
LESSON 4 Production possibility curve

Definition
 The production possibility curve (PPC) represents the
maximum combination of goods and services which can be
produced in an economy, i.e. the productive capacity of the
economy.
Production possibility curve diagrams
 The production possibility curve (PPC) shows the maximum
combination of any two categories of goods and services that
can be produced in an economy, at any point in time.
Essentially, it shows the productive capacity of the economy.
Assume a country can only produce two types of goods:
wooden furniture and olive oil. It has a limited amount of land,
labour and capital. In Figure 4.1, if producers wish to increase
production of olive oil from O1 to O2 then the amount of
wooden furniture manufactured will have to decrease from W1
to W2. The opportunity cost of producing the extra O1 to O2
litres of olive oil is therefore W1 to W2 tonnes of wooden
furniture.
Definition
 The PPC diagram is a
graphical representation of
the maximum combination
of the amounts of goods
and services that can be
produced in an economy,
per period of time.
Causes and consequences of
shifts and movements of the
PPC
• Movements along the curve For a
country to be on its PPC two
conditions have to be met:
• All resources are used — there is no
unemployment of factors of
production.
• There is efficiency in the use of
resources — factors of production are
allocated to their best use/purpose.
Shifts of the curve
 For a country to shift its PPC outwards,there must be economic
growth (see Chapter 29). This can come about in the following
ways:
 An increase in the quality of factors of production (see Chapter
2), such as more highly skilled labour achieved through
investments in education, research and training. Increased
productivity can also be caused by technological advances and
improved production techniques.
 An increase in the quantity of factors of production, such as the
discovery of new resources, the reclamation of land, or net
migration of labour into a country.
 CLASS ACTIVITY HAVING 1 MARKS OF EACH MCQS
 1 Which does not shift the production possibility curve outwards?
 A higher prices
 B higher productivity levels
 C improved education and healthcare
 D technological advances
 2 What do most economies strive to increase?
 A consumer goods
 B opportunity cost
 C productive capacity
 D unemployment
Define the term productive capacity. [2
marks]

Describe what a production possibility

Explain how the concept of opportunity

Explain the two conditions that must hold