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Scarcity requires us to make choices to allocate economic resources to their highest use. And, every choice involves opportunity cost, the next best alternative we give up when choosing something.
Economics deals with scarcity, which arises because the resources available are limited to satisfy our unlimited needs and wants. As a result, we must make choices to allocate resources in the best way to satisfy our needs and wants.
Dimensions of economic resources
Resources have many dimensions, including money, time, goods, and other assets. For example, we have money and want various things. However, our money is limited, so we have to make decisions about what to buy.
Likewise, our time is also a resource. We have to allocate it for some activities.
For example, we have to choose between spending more time at work or on vacation. We cannot possibly use the time to continue working. And, we can’t use it to continue on vacation either.
When we choose to work more, we can earn more money. But, we sacrifice time to have fun with our family or friends.
And, every option we choose has an opportunity cost. For example, if we choose more time to work, the happiness we get with family or friends is a cost we must sacrifice. But, if we choose to spend more time having fun over work, the opportunity cost is that we miss earning more money.
In economics, economic resources refer to factors of production, namely the inputs used to produce goods and services. They fall into four categories:
- Land
- Labor
- Capital
- Entrepreneurship
The latter is related to bringing together the other three factors to produce goods and services. Entrepreneurs play that role. They take risks to start and run a business. They empower land, labor, and capital to produce the products they plan.
As a note, although I mentioned money earlier, according to economists, it is not an economic resource because we cannot use it directly to produce goods and services.
Economic resource allocation requires making choices.
Scarcity makes us have to make choices about what goods and services are produced. Some countries have factors of production in large quantities and of high quality. They can manufacture many goods and services to satisfy the needs and wants of their citizens. They are said to have a factor endowment, which refers to how much resources are available to produce goods and services in a country.
Meanwhile, some other countries have limitations on one or more factors of production. Developing countries, for example, have abundant natural and labor resources. However, they lack capital and entrepreneurship.
In contrast, developed countries such as Japan excel in capital production and entrepreneurship. However, they lack natural resources as raw materials for production.
Since resources are scarce, when using them, we must use them in the best possible way.
Let’s take a beverage manufacturer as an example. They have to use scarce resources to produce beverage products: plastic for bottles, workers, and machines for filling bottles.
If the producer chooses to produce bottled water, then the opportunity lost by not producing soft drinks is the cost. Although it can produce both, the company cannot do it simultaneously due to limited resources.
Take another example. An economy uses more of its workforce to develop the manufacturing sector. But, that means less labor for other sectors such as the service sector. As a result, manufacturing output increased, but not for services. And, people cannot work in both sectors at the same time.
Another example is land. We use it for factory locations and agricultural land. But, for example, because we decide to become agricultural land, we cannot set up production facilities on that land.
Long story short, scarce resources force us to make choices. We must prioritize which choices are most important to us.
Economic resource allocation and economic system
The choice to allocate resources to their highest use raises three basic economic questions:
- What goods and services will we produce?
- How will we produce them?
- How to distribute them among the population?
The answers to the three give rise to an economic system, namely a system for allocating scarce resources. Broadly speaking, there are three economic systems:
- Free market economy
- command economy
- Mixed economy
Free market economy and command economy represent the two extremes of how to answer the three questions above. Meanwhile, a mixed economy lies between these two extremes.
Most countries adopt mixed economies with some variation. For example, the United States and other countries are more inclined towards a free market economy. Meanwhile, China and North Korea are leaning more towards a command economy.
Under a free-market economy, consumption and factors of production are all coordinated through the market. In addition, private ownership of resources is recognized and established through property rights, allowing their owners to maximize their use.
- Then, the market mechanism works to allocate economic resources at their best use. Demand and supply work to determine price and quantity in the market. Market outcomes are the best for producers and consumers. And, prices act as signals for buyers and sellers to make economic decisions about consumption and production.
Meanwhile, the government decides how to allocate resources under a command economy and answers the three basic economic questions above. The system does not allow the private sector to develop and operate for profit.
- The market mechanism doesn’t work. As a result, prices do not reflect supply and demand conditions and fail to be an effective signal. For this reason, resources can be underallocated or overallocated.
