How markets work

1.1 · Free notes

Economic foundations and resource allocation

Key points

• The basic economic problem: resources are scarce but wants are unlimited, so choices must be made.
• Opportunity cost is the value of the next best alternative given up when a choice is made.
• The factors of production are land, labour, capital and enterprise; each earns a reward (rent, wages, interest, profit).
• Economic agents are consumers, producers and government, each making choices with different objectives.
• Production possibility diagrams show maximum possible output combinations; points inside show unused resources, points outside are unattainable with current resources.
• There are three main economic systems: a free market economy (resources allocated by the price mechanism and private firms), a command (planned) economy (the government decides what to produce, such as the former Soviet Union) and a mixed economy (a combination of both, such as the UK).

In more detail

• Worked opportunity cost: a council has £2 million and can build a new library or resurface 40 km of roads. If it builds the library, the opportunity cost is the 40 km of resurfaced roads.
• Three key questions: every economy must decide what to produce, how to produce it and for whom. Markets answer these through prices; governments may answer them through planning.
• Mixed economy: the UK is a mixed economy. Most goods are produced by private firms, but the government provides services such as the NHS and state schools.
• Worked PPF point: an economy makes 60 cars and 20 tractors but could make 60 cars and 35 tractors with its resources, so it is inside its PPF and has unemployed resources.