The Problem of Choice

Since individuals have unlimited wants, but the world only has limited resources, choices have to be made on what we should produce, how, why, and what our other alternatives were. 

Factors of production (AO2)

The factors of production are the four different resource categories needed in order to produce goods or services. They are the following:

1. Land: Natural resources. Examples: Forests, oil reserves, water, and ores. 

2. Labor: The work put in by humans to produce a good or service (both physical and mental work). Examples: Everything from factory workers and farmers to accountants and taxi drivers.

3. Capital: Tools & equipment that are used to produce other goods or services (does not refer to money like in finance). Examples: Roads, factories, and internet infrastructure.

4. Entrepreneurship: No business is started without the human spirit, creativity, and risk-taking. This is referred to as entrepreneurship.

Here is an example of the 4 factors of production in action:

Scarcity (AO2)

• Many of the world's problems can be attributed to the fact that humans have unlimited needs and wants, but planet Earth has limited resources to fulfill these desires (resources are scarce compared to demands). In other words, there is a scarcity of resources in the world.

• Because of this scarcity, we need to ensure we don't overuse resources now, which will limit our ability to use them in the future. 

• This is where sustainability comes in. With sustainable consumption of scarce resources, we can maintain these resources into the future.

  • • Example: If humanity were to fish too much now, fish populations will decrease in the future, negatively affecting future generations' access to food. Sustainable fishing practices are therefore needed to maintain this scarce resource.

Opportunity cost (AO2)

Opportunity cost is a key concept in economics. If you choose to do something, you are always giving a second-best alternative up that you will not be able to do, due to the principle of scarcity:

• Example: If you chose to take HL Economics, you miss out on choosing another HL subject, because time is a scarce resource.

• Example: If you choose to invest $100 in a machine that generates $10 in profit, you miss out on depositing $100 in a bank and getting $5 in interest payments on it, because money is a scarce resource.

This is what opportunity cost refers to: The next-best alternative foregone when an economic decision is made. It is a cost many people don't actively consider: 

• If you have $100 in cash, you may not think there is any cost present, but you are technically missing out on interest if you put that money in a bank account. This missed money is an opportunity cost.

The basic economic questions (AO2)

We have now established that goods and services are made by scarce factors of production, and that economic choices have more costs associated with them than what one may think. So before any production is done, societies have to answer these 3 key questions:

1. What/how many goods and services should be produced?

2. How should these goods and services be produced?

3. For whom should production take place?

There are quite a few different approaches to answering these questions, which we go through in the next point.

Means of answering the economic questions (AO2)

A common way for societies to tackle these challenging questions, is to just let the market decide for themselves. Market forces (supply and demand) will cause the scarce resources to be allocated efficiently.

• Example: Car market: The various companies in the market choose what/how many cars should be produced, how, and for whom. They have the knowledge of the industry and supply chains, and can therefore answer these questions quite well. 

However, the government can also choose to intervene, and answer these questions themselves. This is called government intervention, and can be used if the free market isn't deemed to achieve the best solution by itself. 

• Example: Car market: The government may choose to subsidize electric vehicles to increase its production, which is better for the environment, but isn't something the free market would have chosen by itself.

The level of government intervention in markets depends on which economic system the country has adopted. There are 3 main systems relevant for the IB syllabus:

• Free market economy: Economic choices such as resource allocation and production, are determined by supply and demand from buyers and sellers, with no government intervention. 

  • • Example: The USA*, with large private sectors in nearly all industries.

• Planned economy: The government allocates resources itself. 

  • • Example: The Soviet Union, where the state decided what to produce, how much, and where. 

• Mixed economy: As the name suggests, a mix between the two formerly mentioned. The free market allocates certain resources, while the government intervenes in other markets. 

  • • Most countries in the world are mixed economies, with quite free markets, but also having a government that takes care of certain things like healthcare and education.

    • *The US is also technically a mixed economy, as the government does provide certain services like education.