Scarcity & Resource Allocation

Scarcity

Scarcity is the state of being limited in quantity. Economics is the social science concerned with efficiently using resources to maximize the satisfaction brought to society.

Economic Assumptions

In economics, we make 5 key assumptions:

Society has unlimited wants and limited resources.
Choices must be made due to scarcity. All choices have a trade-off.
Everyone’s goal is to maximize their utility (satisfaction and benefit).
Decisions are made by comparing marginal benefit (benefit of one additional unit) and marginal cost (cost of one additional unit).
Real-life scenarios can be explained and analyzed with simplified models and graphs.

Factors of Production

All resources used in production can be classified into four categories: land, labor, capital, and entrepreneurship.

Land refers to the natural resources we use to produce goods and services. Examples include trees, lakes, and animals.

Labor refers to the paid efforts of people towards a task. For example, a chef making food, or a factory worker assembling a toy.

Capital has 2 subcategories. Physical capital refers to produced goods used to make other goods. For instance, a factory or a robot. Human capital refers to the skills and knowledge of people.

Entrepreneurship refers to the efforts of people to combine factors of production, as well as organize the production and distribution of goods and services.

Resource Allocation

Since all resources are scarce, we have limited resources to address unlimited demands.

Economists have to address these three questions:

What goods and services should be produced?
How much of those goods and services should be produced?
Who should receive the goods and services?

Economic Systems

Economic systems are ways society determines production, resource allocation, and distribution. There are 3 kinds: Market economies, command economies, and mixed economies.

A market economy operates with minimal government intervention. Decisions about production, pricing, and distribution are driven by supply and demand, with individuals and businesses making choices based on profit motives. This type of economy encourages competition, which can lead to greater efficiency, innovation, and a wider range of goods and services. However, market economies can also lead to income inequality and may lack protections for workers or the environment.

In a command economy, the government plays a central role in controlling and managing all economic activity. It makes key decisions about what goods and services should be produced, how they should be distributed, and at what price. In a command economy, there is little to no competition, as the government owns most industries, and individual choice is often limited. One of the goals is to ensure equal distribution of wealth, but this can also lead to inefficiency and lack of innovation due to the absence of competition and incentives.

A mixed economy combines market and command systems. The private sector is mostly left alone, but the government steps in when needed. Most modern economies are like this, like the USA and Sweden.

The Invisible Hand

The invisible hand is a concept describing the self-regulating nature of a free market. When individuals pursue their own interests, they unintentionally contribute to the overall good of society. When people act in their own economic self-interest—whether by seeking profit or trying to buy goods at the best prices—they indirectly promote an efficient allocation of resources without any central planning or government intervention. This leads to the best outcomes for society, even though it wasn't the individuals' intention.

TL;DR

Scarcity is the state of being limited.
We have scarce resources to satisfy unlimited wants, making economic choices necessary.
There are four categories for factors of production — land (natural resources), labor (human effort), capital (tools & skills), and entrepreneurship (organizing production).
Market economies are driven by supply and demand with little government intervention.
Command economies are controlled by the government and have limited individual choice.
A mixed economy combines both, with the government stepping in when needed.
The invisible hand is the self-regulating force of free markets, guiding resources to their most efficient use through individual self-interest.