Scarcity and Choice

Road space throughout the world is becoming increasingly scarce as the demand for motor transport increases each year what do you think are some of the best solutions to reducing the problem of congestion on our roads?

The Economist's Dictionary of Economics defines economics as "The study of the production, distribution and consumption of wealth in human society" Another definition of the subject comes from the economist Lionel Robbins, who said in 1935 that "Economics is a social science that studies human behaviour as a relationship between ends and scarce means which have alternative uses. That is, economics is the study of the trade-offs involved when choosing between alternate sets of decisions." It is this idea that economics is a social science that is so intriguing we can never be sure how people, businesses and governments will respond to certain situations and policies. The purpose of economic activity It is often said that the central purpose of economic activity is the production of goods and services to satisfy our changing needs and wants. The basic problem is about scarcity and choice. All societies face the problem of having to decide: (i) What goods and services to produce: Does the economy uses its resources to operate more hospitals or hotels? Do we make iPhones or double-espressos? Does the National Health Service provide free IVF treatment for childless couples? How best to produce goods and services: What is the best use of our scarce resources? Should school playing fields be sold off to provide more land for affordable housing? Should coal be produced in the UK or is it best imported from other countries? Who is to receive goods and services: Who will get expensive hospital treatment and who not? Should there be a minimum wage? If so, at what level should it be set?

(ii)

(iii)

Scarcity If the supply of a good or service is low, the market price will rise, providing there is sufficient demand. Whenever there is excess supply in a market, we expect to see prices falling. The development of virtually every type of society can be described as the uncovering of new wants and needs - which producers attempt to supply by using the available factors of production. For a perspective on the achievements of countries in meeting peoples basic needs, the Human Development Index produced by the United Nations is worth reading. IKEA sells to millions of consumers throughout the world does it meet our needs and wants?

Making choices Because of scarcity, choices have to be made by all consumers, firms and governments. Over six million people travel into London each day. They have to make choices about when to travel, whether to use the bus, the tube, to walk or cycle or whether to work from home. Millions of decisions are being taken, many of them are habitual but somehow on most days, people get to work on time and they get home too! This is a remarkable achievement, and for it to happen, our economy must provide the resources and the options for it to happen. Trade-offs when making choices Making a choice made normally involves a trade-off - in simple terms, choosing more of one thing means giving up something else in exchange. 1. Housing: Choices about whether to rent or buy a home a huge decision to make and one full of uncertainty given the recent volatility in the British housing market! There are costs and benefits to renting a property or in choosing to buy a home with a mortgage. Both decisions involve a degree of risk. People have to weigh up the costs and benefits of the decision. 2. Working: Do you work full-time or part-time work? Is it worth your while studying for a degree? How have these choices been affected by the introduction of university tuition fees? 3. Transport and travel: The choice between using Euro-Tunnel, a speedy low-cost ferry or an airline when travelling to Western Europe. Your choices about which modes of transport to use to get to and from work or school each day.

Basic cost-benefit analysis In many of these decisions, people consider the costs and benefits of their actions economists make use of the marginal idea, for example what are the costs of consuming a little extra of a product and what are the costs. People are often likely to go ahead with a purchase if they estimate that the marginal benefits are greater than the marginal costs. Consumer welfare and rationality What makes people happy? Why despite several decades of rising living standards, surveys of happiness suggest that people are not noticeably happier than previous generations? Typically we tend to assume that, when making decisions in the market place, people aim to maximise their welfare. They have a limited income and they seek to allocate their money in a way that improves their standard of living. Of course in reality consumers rarely behave in a perfectly informed and rational way. We will see later that often decisions by people are based on imperfect or incomplete information which can lead to a loss of welfare not only for people themselves but which affect other and our society as a whole. As consumers we have all made poor choices about which products to buy. Behavioural economics is an exciting strand of the subject that looks at whether we are rational in our everyday decisions. Opportunity Cost There is a well known saying in economics that there is no such thing as a free lunch! Even if we are not asked to pay a price for something, scarce resources are used up in the production of it and there must be an opportunity cost involved. Opportunity cost measures the cost of any choice in terms of the next best alternative foregone. Work-leisure choices: The opportunity cost of deciding not to work an extra ten hours a week is the lost wages foregone. If you are being paid 6 per hour to work at the local supermarket, if you choose to take a day off from work you might lose 48 of income. Government spending priorities: The opportunity cost of the government spending nearly 10 billion on investment in National Health Service might be that 10 billion less is available for spending on education or the transport network. Investing today for consumption tomorrow: The opportunity cost of an economy investing resources in new capital goods is the current production of consumer goods given up. Making use of scarce farming land: The opportunity cost of using arable farmland to produce wheat is that the land cannot be used in that production period to harvest potatoes. Economic Systems

An economic system is best described as a network of organisations used by a society to resolve the basic problem of what, how much, how and for whom to produce. 1. Traditional economy: Where decisions about what, how and for whom to produce are based on custom and tradition. Land is typically held in common i.e. private property is not well defined. This BBC news article looks at the traditional economy of Vanuatu. 2. Free market economy: Where households own resources and free markets allocate resources through the workings of the price mechanism. An increase in demand raises price and encourages firms to switch additional resources into the production of that good or service. The amount of products consumed by households depends on their income and household income depends on the market value of an individuals work. In a free market economy there is a limited role for the government. Indeed in a highly free market system, the government limits itself to protecting the property rights of people and businesses using the legal system, and it also seeks to protect the value of money or the value of a currency. 3. Planned or command economy: In a planned or command system typically associated with a socialist or communist economic system, scarce resources are owned by the state (i.e. the government). The state allocates resources, and sets production targets and growth rates according to its own view of people's wants. The final income and wealth distribution is decided by the state. In such a system, market prices play little or no part in informing resource allocation decisions and queuing rations scarce goods. 4. Mixed economy: In a mixed economy, some resources are owned by the public sector (government) and some resources are owned by the private sector. The public (or state) sector typically supplies public, quasi-public and merit goods and intervenes in markets to correct perceived market failure. Sectors of Production Production of goods and services takes place in different sectors, when added together they give us a figure for a nations gross domestic product (GDP). These sectors are as follows: 1. Primary sector: This involves extraction of natural resources e.g. agriculture, forestry, fishing, quarrying, and mining 2. Secondary sector: This involves the production of goods in the economy, i.e. transforming materials produced by the primary sector e.g. manufacturing and the construction industry 3. Tertiary sector: the tertiary sector provided services such as banking, finance, insurance, retail, education and travel and tourism 4. Quaternary sector: The quaternary sector is involved with information processing e.g. education, research and development

Manufacturing industry in the United Kingdom only accounts for 15 per cent of national output. The bulk of our income and employment comes from the service sector.

Suggested reading on opportunity cost and trade offs Could scrapping Trident save the planet? (Guardian, November 2006) Counting the cost of the Iraq War (BBC news, March 2008) Cuban reforms create goodwill (BBC news, April 2008) Scarcity in an age of plenty (Joseph Stiglitz, Guardian, June 2008)