The Economic Problem

The Economic Problem

1. Scarcity

   • Infinite needs and wants but only limited resources available to meet the needs
   • Economy require the best way to allocate the resources to maximise the benefit to the society as a whole
     • Maximising objective of each agents combined with signals of price(rewards of factor of production) helps to allocate resources where consumers want them most
       • Adam Smith
         • Invisible hand moving resources to their best use
   • Opportunity Cost
     • The next best alternative forgone when an economic decision is made
   • Economic Goods
     • Scare and opportunity cost involved

2. Free Goods

   • No opportunity cost involved
     • E.g. Air

3. Economic Resources

   • Factors of Production
     • Land
       • Reward:Rent
     • Labour
       • Reward:Wages
     • Capital
       • Reward:Interest
     • Enterprise
       • Reward:Profit
     • Factor Market
       • Markets where factors of production are bought and sold

4. Objectives of individuals, firms and government

   • Individuals
     • Rational consumers
     • Decisions based on maximising our own welfare
   • Workers
     • Higher wages
     • Better working conditions
     • Job security
   • Firms
     • Maximise profits
   • Government
     • Political Objective
     • Chances of re-elected

5. Free market economy

   • Limited intervention of the government
   • High prices
     • Indicates profits
       • Signals higher output or new firms entering the market
         • E.g. Rise in oil prices
           • Consumers tend to ration more
           • Development of new oilfields in tougher environments
             • Supply increased due to higher profit incentive
     • Incentive Function
     • Rationing function
     • Signalling function

6. Assumption

   • Assume consumers wants to maximise their own satisfaction
   • Assume firms want to maximise profit