The fundamental economic problem of scarcity, opportunity cost, the factors of production, the production possibility frontier, and the market, command and mixed economic systems.

What this dot point is asking

CCEA wants you to explain the basic economic problem, define and apply opportunity cost, identify the four factors of production, use the production possibility frontier to show scarcity, choice and trade-offs, and compare how the market, command and mixed systems answer the three questions of what, how and for whom to produce.

Scarcity, choice and opportunity cost

Scarcity forces three fundamental questions on every society: what to produce, how to produce it, and for whom to produce. Opportunity cost applies at every level: a government choosing to spend more on health gives up the schools that money could have funded; a firm using land for a factory gives up its farming use; a student revising economics gives up time for another subject.

The factors of production

Resources are grouped into four factors of production, each earning a reward:

• Land - all natural resources (the reward is rent).
• Labour - human physical and mental effort (the reward is wages).
• Capital - manufactured aids to production such as machines and factories (the reward is interest).
• Enterprise - the entrepreneur who organises the other three factors and bears risk (the reward is profit).

The production possibility frontier

The PPF illustrates the core ideas at a glance. A point on the curve is productively efficient (all resources used fully); a point inside the curve shows unemployed or wasted resources; a point outside is unattainable with current resources. Moving along the curve shows the trade-off: producing more of one good means producing less of the other.

The curve is usually drawn concave to the origin (bowed outward) because of increasing opportunity cost: factors of production are not equally suited to producing both goods, so as you switch resources, ever larger sacrifices are needed.

Economic systems

The three questions of what, how and for whom can be answered in different ways, defining three economic systems.

• Free market (capitalist) economy. Resources are allocated by the price mechanism and private decisions. Consumer sovereignty and the profit motive drive what is produced; there is little or no government role.
• Command (planned) economy. The state owns resources and a central plan decides what, how and for whom. It aims for equity and national priorities rather than profit.
• Mixed economy. A combination of the two, with a private sector guided by markets and a public sector providing public and merit goods and correcting market failure. Almost all real economies, including the UK, are mixed.

Why it matters for the rest of AS 1

Scarcity and choice are the foundation of everything that follows. Markets exist precisely because society must allocate scarce resources; demand and supply are how a market answers the three questions; market failure is what happens when the market answers them badly; and government intervention is the attempt to do better. Keep the PPF and opportunity cost in mind as analytical tools throughout the unit.

Try this

Q1. State the four factors of production and the reward earned by each. [4 marks]

• Cue. Land - rent; labour - wages; capital - interest; enterprise - profit.

Q2. Explain why a production possibility frontier is usually drawn concave to the origin. [4 marks]

• Cue. Increasing opportunity cost: factors are not equally suited to both goods, so larger sacrifices are needed as output of one good rises.

Q3. Using examples, explain the difference between a command economy and a mixed economy. [6 marks]

• Cue. Command - state ownership and central planning; mixed - private sector guided by markets plus a public sector correcting market failure and providing public goods.