AP® Macroeconomics review sheet from Aim for Five (aimforfive.com/macro/units/1/1-1)
Unit 1 · Topic 1.1
1.1 Scarcity
Scarcity is the basic problem of economics: wants are unlimited, but the resources used to satisfy them are limited. Because of that, every person, business and government has to choose, and every choice means giving something up. The rest of the course is about how those choices get made.
Key terms
- scarcity
- economic resources
- factors of production
- capital
- entrepreneurship
- trade-off
What scarcity means
A resource is scarce when there isn't enough of it to give everyone all they want for free. Time, workers, land, oil, machines and money to spend are all scarce. Even a billionaire faces scarcity, because they still have only 24 hours in a day.
Scarcity is not the same as a shortage. A shortage is temporary: it happens in one market when the price is too low (you'll see this in 1.6). Scarcity is permanent and affects everything. Concert tickets at a price of $50 might run out (a shortage), but even if the price rose until the shortage ended, the tickets would still be scarce.
Because resources are scarce, every society has to answer three questions: what to produce, how to produce it and who gets it. Scarcity forces a trade-off, which means getting more of one thing requires accepting less of something else.
The four factors of production
Economists call the inputs used to make goods and services economic resources, or factors of production. There are four, and each one earns a type of income when firms pay for it.
| Factor | What it is | Example | Income it earns |
|---|---|---|---|
| Land | Natural resources, as they come from nature | Farmland, oil, fish, water | Rent |
| Labor | Human effort, physical or mental | A nurse's shift, a coder's work | Wages |
| Capital | Things made by people and used to make other goods | Tractors, ovens, factories, laptops used at work | Interest |
| Entrepreneurship | Taking risks and organizing the other three to start or run a business | Opening a food truck | Profit |
Capital is not money
In everyday speech, "capital" often means money. In economics, physical capital means tools, machines and buildings. Money can buy capital, but money itself doesn't produce anything. A $10,000 bank balance is not capital; the $10,000 pizza oven a restaurant buys with it is.
Human capital is the knowledge and skills workers gain from education and training. It makes labor more productive. A welder who takes a certification course has more human capital, even though the number of workers hasn't changed. This idea comes back in 5.6, where more human capital helps an economy grow.
Choices and trade-offs
Since you can't have everything, every choice has an opportunity cost: the value of the next-best option you give up. If you spend Saturday working a shift instead of studying, the opportunity cost is the studying (and the higher grade it might have earned), not the money you made.
Whole countries face the same problem. Workers and factories used to build military equipment can't also build hospitals at the same time. Topic 1.2 shows these trade-offs on a graph, the production possibilities curve.
Worked examples
Try each one yourself first, then open the solution.
- Example 1
Sorting resources into factors of production
A bakery uses each of the following. Classify each one as land, labor, capital or entrepreneurship: (a) the wheat-growing field the flour came from, (b) the bakers who knead the dough, (c) the industrial mixer, (d) the owner who borrowed money to open the shop and decides what to sell, (e) the $5,000 in the bakery's bank account.
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- Step 1: (a) The field is a natural resource, so it's land.
- Step 2: (b) The bakers supply human work, so that's labor.
- Step 3: (c) The mixer was made by people and is used to make bread, so it's capital.
- Step 4: (d) The owner takes the risk and organizes the other inputs, so that's entrepreneurship.
- Step 5: (e) The trap: money is not a factor of production. It can buy capital or pay workers, but the cash itself makes nothing.
Answer: (a) land, (b) labor, (c) capital, (d) entrepreneurship, (e) not a factor of production; money is not capital in economics.
Common mistakes
- Calling money "capital." Capital means tools, machines and buildings used in production; money only buys them.
- Mixing up scarcity and shortage. Scarcity never goes away; a shortage is a temporary gap in one market when the price is below equilibrium.
- Naming the opportunity cost as everything you gave up. It's only the single next-best alternative.
- Thinking only poor countries face scarcity. Every economy has limited resources, so every economy must choose.
On the exam
- Multiple-choice questions often ask you to classify an example as one of the four factors or to identify the opportunity cost of a choice. Read for the next-best option, not the sum of all options.
- Unit 1 is only 5–10% of the multiple-choice section, but its ideas (opportunity cost, trade-offs, resources) show up in every later unit.
Connected topics
Videos
Check yourself
4 questions on 1.1 Scarcity. Pick an answer to see if you got it, and why.
Which of the following best explains why every society faces scarcity?
A bakery buys a new delivery van to bring bread to grocery stores. In economics, the van is an example of which factor of production?
Which of the following is an example of the factor of production economists call land?
Which of the following best illustrates entrepreneurship?
0 of 4 answered