Scarcity is one of the fundamental issues in economics. The issue of scarcity means we have to decide how and what to produce from limited resources. It means there is a constant opportunity cost involved in making economic decisions.
Economics solves the problem of scarcity by placing a higher price on scarce goods. The high price discourages demand and encourages firms to develop alternatives.
How does economics solve the problem of scarcity?
If we take a good like oil. The reserves of oil are limited, there is scarcity of the raw material. As we use up oil reserves, the supply of oil will start to fall.
Diagram of fall in supply
If there is scarcity of a good the supply will be falling and this causes the price to rise. In a free market this rising price acts as a signal and therefore demand for the good falls (movement along demand curve). Also the higher price of the good provides incentives for firms to:
- Look for alternative sources of the good e.g. new supplies of oil from Antarctic
- Look for alternatives e.g. solar panel cars.
- If we were unable to find alternatives to oil, then we would have to respond by using less transport. People would cut back on transatlantic flights and make less trips.
Therefore, in a free market there are incentives for the market mechanisms to deal with the issue of scarcity.
However, the market can also have market failure. For example, firms may not think about the future until it is too late. Therefore, when the good becomes really scarce there might not be any practical alternative that has been developed.
Another problem with the free market is that since goods are rationed by price, there may be a danger that some people cannot afford to buy certain goods; they have limited income. Therefore, economics is also concerned with the redistribution of income to help everyone be able to afford basic necessities.
One solution to dealing with scarcity is to implement quotas on how much people can buy. An example of this is the rationing system that occurred in the Second World War. Because there was a scarcity of food, the government had strict limits on how much people could get. This was to ensure that even people with low incomes had access to food – a basic necessity.
A problem of quotas is that it can lead to a black market; for some goods, people are willing to pay high amounts to get extra food. Therefore, it can be difficult to police a rationing system. But, it was a necessary policy for the second world war.