Model Essay

“The Central Problem of Economics is scarcity and choice.” Is this statement true? (25)

Scarcity is defined as a situation in which resources are not enough to satisfy everybody’s wants. The outcome of satisfaction is not to the level we want it to be. Scarcity is the most fundamental concept in Economics. Scarcity is based on a few assumptions.

First, is that man’s wants are unlimited. Man is never satisfied with his current level of consumption, and he always wants more. Second, is that the world’s resources are limited. These resources are the factors of production of land, labour, capital and entrepreneurship. Land refers to natural resources and all the fruits of the earth. Labour refers to human effort and skill. Capital refers to any machine or technology that can produce things. Entrepreneurship is the ability to take risks, organize and plan production effectively. All countries have a finite amount of these.

Based on these assumptions, it is clear that it is not possible to produce all that we want. Some goods will have to be sacrificed to obtain more of other goods. This means that a choice has to be made.

To illustrate this concept, a man has a certain amount of money to spend. He decides to spend it all on sweets and chocolates. He can spend half his money on sweets, and the other half on chocolates. If he wants more sweets, he will have to give up some chocolates and vice versa. In the same way, for a firm, its resources are limited. If it decides to produce more of product A, it has to give up some production of good B. Thus, scarcity applies both to consumers and producers.


Figure 1: Production possibility curve
The Production Possibility Curve (PPC) further illustrates scarcity. The PPC shows all the possible combinations of 2 goods which a firm can produce, given a fixed amount of resources. At combination a, the producer can produce 100 units of X and 0 units of Y. While at combination b, he can produce 200 units of Y and 0 units of X. He may also choose to produce at c, 70 units of X and 150 units of Y. All these combinations are possible combinations of goods that can be produced. To produce more of one good, the other has to be sacrificed. Combinations d and e are not attainable, which also shows scarcity. It is the same at country level.

Scarcity forces us to choose. Since we cannot have everything, we have to decide on which one we will have to forgo. Since comething has to be forgone, there is a cost involved. In a world of scarcity, there is a cost of sacrifice involved in satisfying a particular want. This cost is called opportunity cost, and is defined as the highest valued alternative that had to be foregone to satisfy the particular want.

The basic economic problem is scarcity. Because of scarcity, we have to choose carefully on the use of our limited resources. The consumer faces the problem of satisfying his unlimited wants. He wants to have infinite satisfaction, from his finite purchasing power. Scarcity makes this impossible. As such, he will have to make a choice, based on relative opportunity costs, on which goods and services he will spend. He will have to decide which goods he has to forego and which he wants to consume.

For a producer, he will want to make infinite profit, using his finite resources. Likewise, scarcity makes this impossible, and he will have to make a choice, based on relative opportunity costs, on which good he wants to produce.

From a Macroeconomic perspective, the basic Macroeconomic concerns of the government are inome distribution and economic stability. The relative weightage given to these concerns will determine what type of policies the government decides to employ.

Income distribution is important to create a ‘fair’ and a ‘just’ state. This is a Macroeconomic objective, and it requires government intervention through progressive taxation, social insurance, benefits, etc. Reducing large income gaps and poverty are important goals of development and are hallmarks for civilised society. Extreme inequality and widespread poverty can result in social unhappiness and unrest, which in turn will result in political and social instablilty. The crime rate rises, illiteracy goes up, welfare costs rise, which all put a great strain on the economy.

The concept of scarcity comes into play here. Scarcity means that the resources of a counry are limited. As such, every available resource must be used to its fullest potential.The government needs to appreciate this when deciding the level of income equality it hopes to achieve.

If the poor are to be given a lot of financial aid, they may be spurred to further improve their skills, and contribute more to the economy. As the saying goes, a happy worker is a good worker. Likewise, if the poor are left behind as the country prospers, they may feel alienated. As such, they may refuse to work and may even resort to illegal activities. Since the country’s population is limited, a waste of scarce resources would be disastrous.

However, if too much aid is given to the poor, and too much money is taken from the rich, a whole new set of problems may arise. The poor may start to become over-dependent on government aid. This is the situation currently occurring in many Western developed countries. The poor live off their welfare payments and they contribute nothing in return to society. To support such high amounts of aid, the rich would have to be taxed a high amount, which may result in great unhappiness and discontent. This may result in the rich evading tax payments or even force them to migrate to other countries that tax less. This scenario too would be detrimental to the economy as the government would receive lesser tax revenue.

The concerns highlighted above mean that the government will have to make tough decisions. The government will have to decide on the best policy based on the opportunity cost of the available measures.

In a free market economy, the pricing system is prone to high unemployment, inflation and Balance Of Payments (BOP) difficulties. Hence, the government seeks to stabilise the economy. In this, it has four aims.

First, is full employment. Unemployment wastes sarce resources, as stated above, and brings hardships to those without jobs. Full employment is not equal to zero unemployment. It is the employment level asociated with some frictional unemployment.

Second, is price stability. This provides a stable environment for investment and growth. Price stability is not zero inflation, but usually refers to 2-3% mild inflation that is necessary to stimulate growth.

Third, is a healthy BOP. This is to ensure healthy reserves and a stable exchange rate. Last is economic growth, which is the increase in real national income per capita, which should ensure higher living standards.

Ideally, the government would seek to achieve all these aims. However, this is not always possible. Sometimes, to achieve one aim, another has to be compromised. For example, there is large-scale unemployment due to the lack of demand. To counter this, the government will employ an expansionary fiscal policy to boost demand. Government spending on public projects will increase to boost demand. However, this may, in turn, cause demand-pull inflation.

Thus, the concepts of choice and cost come into play again. The government will have to make choices based on the costs of the different measures available. Hence the statement “The Central Problem of Economics is scarcity and choice” is true.