Scarcity, the fundamental economic problem, finite resources and infinite wants, the factors of production, opportunity cost, and the basic economic questions of what, how and for whom to produce.

What this dot point is asking

AQA wants you to explain the fundamental economic problem, scarcity, and show that it forces every economy to make choices. You must define the four factors of production, explain opportunity cost, and set out the three basic economic questions (what, how and for whom to produce). This is the foundation of section 4.1.2, and the language reappears in almost every later answer.

Scarcity and the economic problem

Wants are unlimited because human beings always desire more, higher quality, or new goods and services. Resources, by contrast, are limited at any moment in time. This mismatch means that producing more of one good requires producing less of another. Scarcity is therefore distinct from poverty: even a rich economy faces scarcity, because its resources, however large, are still finite relative to total wants.

A useful distinction is between free goods and economic goods. A free good (for example, sunlight in most contexts) has no opportunity cost because it is available without using scarce resources. An economic good requires scarce resources to produce, so it carries an opportunity cost.

The factors of production

Economists group all productive resources into four factors, each earning a distinct reward:

• Land, all natural resources (fields, minerals, sea, climate). Reward: rent.
• Labour, the human effort, both physical and mental, used in production. Reward: wages.
• Capital, man-made aids to production such as machinery, factories and tools (not money, which is financial capital). Reward: interest.
• Enterprise, the factor that organises the other three and bears the risk of production. Reward: profit.

The quantity and quality of these factors determine an economy's productive capacity. Improving labour through education and training, or capital through net investment, expands what the economy can produce and shifts the production possibility frontier outwards.

Opportunity cost

Opportunity cost applies to individuals, firms and governments. A firm that uses a factory to make cars cannot simultaneously use it to make vans; the forgone vans are the opportunity cost. A government that funds defence forgoes the next best public spending, for example healthcare. Opportunity cost is also the gradient of the production possibility frontier: the rate at which one good must be sacrificed to gain more of another.

The three basic economic questions

Every economic system, whether a free market, a command economy or a mixed economy, must answer:

1. What to produce? Which goods and services, and in what quantities, given limited resources.
2. How to produce? Which combination of factors and which methods (labour-intensive or capital-intensive).
3. For whom to produce? How output is distributed, which depends on the distribution of income and wealth.

In a market economy the price mechanism answers these questions through the interaction of demand and supply. In a command economy the state plans them. In practice almost all economies are mixed, combining markets with government provision and regulation.