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This lesson introduces the foundational concepts of economics: the economic problem, scarcity, opportunity cost, the production possibility frontier, and the distinction between positive and normative economics. These ideas underpin everything you will study at A-Level and are central to AQA Paper 1 (Markets and Market Failure).
Key Definition: The economic problem arises because there are unlimited wants but only limited (scarce) resources with which to satisfy them. This means choices must be made about how to allocate resources.
Economics, at its core, is about making choices. Every society — whether a remote village or a modern industrial economy — faces the same three fundamental questions:
These questions arise directly from the problem of scarcity.
Key Definition: Scarcity exists when there are insufficient resources to satisfy all human wants. Resources are finite; wants are infinite.
The four factors of production are the scarce resources available to an economy:
| Factor of Production | Definition | Examples | Reward |
|---|---|---|---|
| Land | All natural resources | Oil, farmland, rivers, minerals | Rent |
| Labour | Human effort (physical and mental) | Workers, managers, entrepreneurs | Wages |
| Capital | Man-made aids to production | Machinery, factories, computers | Interest |
| Enterprise | The factor that organises the other three and bears risk | Entrepreneurs, business founders | Profit |
Exam Tip: Do not confuse 'capital' in economics with money. Capital refers to physical goods used in the production process — machinery, tools, and equipment. Money is a medium of exchange, not a factor of production.
Because resources are scarce relative to wants, every decision to produce one thing means sacrificing the opportunity to produce something else. This leads directly to the concept of opportunity cost.
Key Definition: Opportunity cost is the value of the next best alternative forgone when a choice is made.
Opportunity cost is one of the most important concepts in economics and applies to individuals, firms, and governments alike.
Exam Tip: In essay questions, always identify the specific next best alternative — not just "other things." Saying "the opportunity cost of building HS2 is the new hospitals that could have been built" is far stronger than "the opportunity cost is other spending."
A free good is one where consumption by one person does not prevent consumption by another, and it exists in abundance — for example, air (in most contexts). Free goods have zero opportunity cost because using them does not require sacrificing anything else. However, most goods are economic goods, which are scarce and therefore carry an opportunity cost.
Key Definition: A production possibility frontier (PPF) shows the maximum possible combinations of two goods or services that an economy can produce when all resources are fully and efficiently employed, given the current state of technology.
The PPF is a crucial analytical tool in A-Level economics. It illustrates scarcity, opportunity cost, efficiency, and economic growth.
As an economy shifts production from one good to another, it must use resources that are less well suited to the new good. For example, moving resources from manufacturing consumer goods to producing military equipment means redeploying workers and factories not designed for military production, resulting in diminishing returns and increasing opportunity costs.
If opportunity costs were constant (resources perfectly transferable), the PPF would be a straight line.
The PPF can shift outward (economic growth) or inward (economic decline):
| Shift | Cause | Example |
|---|---|---|
| Outward shift | Increase in quantity or quality of resources, or technological improvement | Discovery of North Sea oil; improved AI technology; immigration increasing labour supply |
| Inward shift | Destruction of resources, natural disaster, or population decline | War, pandemic, depletion of natural resources |
| Pivotal shift | Growth in one sector only | Advances in renewable energy technology shift the PPF outward only for energy-related goods |
Exam Tip: When drawing PPF diagrams, always label both axes clearly. If the question asks about a specific sector, consider whether the shift is parallel (uniform) or pivotal (asymmetric). This distinction can earn you analysis marks.
Economics uses models and theories to explain and predict behaviour. Two key methodological distinctions are important at A-Level.
| Type | Definition | Example | Can be tested? |
|---|---|---|---|
| Positive statement | A statement of fact that can be tested or verified with evidence | "Inflation in the UK was 4.2% in 2024" | Yes |
| Normative statement | A statement of opinion or value judgement that cannot be tested | "The government should reduce inflation" | No |
Key Definition: A positive statement is an objective statement that can be tested against evidence. A normative statement is a subjective statement based on value judgements — it includes words like "should," "ought," or "fair."
Lionel Robbins (1932) was influential in arguing that economics should focus on positive analysis, separating scientific inquiry from value judgements. However, in practice, economic policy always involves normative judgements about what outcomes are desirable.
Economists build simplified models of reality — such as supply and demand diagrams — to isolate key relationships. All models involve assumptions. The assumption of ceteris paribus (all other things being equal) is used extensively: when analysing the effect of a price change on demand, we assume income, tastes, and other factors remain constant.
Evaluation point: Economic models are simplifications of a complex reality. They may fail to capture irrational behaviour, incomplete information, or the influence of culture and institutions. The 2008 financial crisis exposed the limitations of models that assumed rational behaviour and efficient markets.
Adam Smith (1776) argued in The Wealth of Nations that the division of labour — where production is broken into separate tasks and each worker specialises in one task — dramatically increases productivity.
Exam Tip: In evaluation, always consider both micro and macro implications. Specialisation benefits individual firms through efficiency but can create macroeconomic vulnerability if an economy becomes overly dependent on one sector — as seen in regions of the UK that relied heavily on coal mining or steel production.
Economies can be classified by how they answer the three fundamental economic questions:
| Economic System | Resource Allocation | Strengths | Weaknesses |
|---|---|---|---|
| Free market | Price mechanism; private ownership | Consumer sovereignty; incentives for innovation; efficient resource allocation | Inequality; market failure; under-provision of public goods |
| Command (planned) | Central government planning | Can reduce inequality; can prioritise merit goods | Information problems; lack of incentives; inefficiency |
| Mixed economy | Combination of market forces and government intervention | Balances efficiency with equity; government corrects market failures | Difficulty finding the right balance; government failure possible |
Most modern economies, including the UK, are mixed economies — they rely primarily on the price mechanism but with significant government intervention through taxation, regulation, and public spending.