Terms Beginning With 's'

Scarcity

  • November 03, 2020
  • Team Kalkine

What is meant by scarcity?

Scarcity refers to the lack of resources in the economy to fulfil the unlimited wants of the society. It is the finiteness of resources as opposed to the infinite want of resources by individuals and businesses. It is the economic concept of rationally, utilising the available resources as they are limited.

Economics is the study of efficient usage of scarce resources and is the channel through which people can choose between the trade-offs based on their decisions. Either it involves enjoying a balanced supply of the scare resource over a longer period or it is higher usage in the current period followed by no usage in future periods.

It is always better to have a balanced approach when dealing with resources, as all resources are scarce. The study of economics assumes that resources are limited, and thus, their usage needs to be rationed.

Commodities that are freely available are more likely to become scarce over time. The theory of scarcity implies that even free resources have a cost attached to them. This cost is the continued usage of the goods in the future. If the free goods are exhausted, then it would be at the cost of living in a world that is deprived of such resources. Economics helps in rectifying this problem through resource allocation.

What is the problem of scarcity in economics?

The problem of scarcity refers to the problem that arises because of limited availability of resources in the economy. When faced with a choice to exploit a resource or to find an alternative, consumers must decide upon one. The option that is forgone, or not opted for, is the opportunity cost.

Economics studies how and what to produce out of these scarce resources and the problem of scarcity is one of the foundation blocks in achieving the same.

What are the different types of scarcity?

Scarcity can be of three types, based on the causal factors behind it:

  1. Demand-Induced Scarcity: This refers to the scarcity that arises because of demand being higher than the supply. As people demand more than the optimal level, the supply falls short of the demand and a scarcity arises.
  2. Supply-Induced Scarcity: This is the scarcity that arises because of decreased supply due to unforeseen calamities or disasters or production constraints. The supply is lesser than the optimal level, and thus, it is not able to fulfil the demand in the economy.
  3. Structural Scarcity: This is the scarcity that occurs when different sections of the society have unequal access to the resources.

How does scarcity affect the markets?

As resources become scarce, their prices rise. This can be seen in the demand and supply graphs shown below. In both the cases, prices are rising. Thus, scarce goods are more likely to influence prices.             

Since scarce goods experience greater demand, they are more likely to grasp higher prices. Consider, for instance, high-end technological devices. Devices that involve a large amount of skill and high level of research and development in their inception are more expensive than the products that involve a less advanced level of technology.

Why are free and abundant resources considered scarce?

Resources that are readily available like time or oxygen, can also be considered scarce. Consider the fact that air is free and can be consumed by all, irrespective of the socio-economic conditions of its consumer. However, the choice arises when the consumer must decide whether to keep the air pollution free or not.

As individuals cause more and more harm to the environment, the breathable air starts to deplete. Thus, even an abundant resource can be brought to its end if corrective measures are not adopted in time.

Similarly, even time and money are scarce resources. Consider the 24 hours available to humans in a day. Every individual, irrespective of their socio-economic conditions, has the same amount of time in a day. However, the trade-off exists between leisure and work. Those who do not work and spend time doing leisure might have a lack of money while those who earn a lot, might be deprived of a good night’s sleep or enough leisure time.

Thus, a trade-off exists even between free and readily available resources. This means that almost all resources available to humans are scarce. Thus, they need to be utilised wisely, and an appropriate trade-off must be made.

What are the effects of scarcity?

Prolonged inaction upon the problem of scarcity can lead to a depletion of resources. Continued usage of resources by firms may not end up well in the long run and may cause market distortions.

Moreover, the price increase that arises because of scarcity of resources can make the distribution of goods less equitable. Thus, the inequalities in the distribution of goods can further increase because of scarcity.

Most importantly, if resources are left to deplete over time, it can lead to severe environmental damage.

Are there any solutions to overcome the scarcity of resources?

Economics suggests that goods will always remain scarce because human wants are unlimited. Thus, there is no one shot solution to combat scarcity. However, small steps can be taken to ensure that resources remain equitable and last over several generations.

Governments can introduce measures to ensure that wastage of resources does not take place. Stricter laws need to be implemented to ensure that more sustainable lifestyles are adopted by people.

Countries can also look for alternatives to the existing resources. This would require increased costs in terms of the research and development required to find such solutions, as well as capital to execute them.

Quotas can be implemented on the current usage of resources to ensure that a lot of resources are not consumed by a single section of the society.

Pollution control, less usage of fuel, curbing deforestation, going green are all lifestyle choices that can be adopted to ensure that resources last for a longer period and remain equally available for all sections of society.

What is meant by deflation? Deflation refers to the fall in prices of goods and services in an economy. Deflation increases the purchasing power of a currency as goods become cheaper than usual. Deflation is the opposite of an inflationary scenario, where prices of goods and services in an economy rise. Deflation generally indicates a highly productive economy but decreasing prices could also point towards a contraction of demand. Deflation can also lead to a financial crisis as the prices could crash down to unforeseen levels. To some degree, deflation helps in increasing consumer spending, and it allows domestic consumers to purchase a higher quantity of products for the same price as before. On the contrary, deflation can sometimes be a sign of an impending recession. The speculation of an incoming recession may urge consumers to save more today, which can lead to a further contraction in demand.   What are the causes of deflation? Two macroeconomic factors can cause deflation: Decline in Aggregate Demand: Aggregate demand (AD) refers to the total demand for all goods and services in a country. A drop in demand has a direct relation to an increase in prices. As demand falls, there is not enough consumption to meet the supply in the economy. Increase in Aggregate Supply: Aggregate supply (AS) refers to the total supply of goods and services available in a country. For the same reason as explained above, when the supply exceeds the demand, the prices decline. On a broader scale, deflation is caused by the disequilibrium in the AD-AS model. Deflation is the economic state where the money supply in the economy remains the same, but the population and the economy both expand. Therefore, to maintain equilibrium, the amount of cash in an individual’s portfolio decreases. This leads to an overall increase in the value of the currency, unlike in inflation. Deflation is the scarcity of hard cash in an economy which makes it more valuable to hold. The scenario of deflation can also occur when the productive efficiency of a nation increases due to better technology. Higher competitiveness levels also lead to firms lowering their prices as they save up on their costs. As prices are lowered, consumers are left with more cash in their portfolio, and thus deflation occurs. What are the economic impacts of deflation? Deflation can lead to the following macroeconomic impacts: Unemployment: As there is a lack of money in circulation, there is contracted demand. This may lead to producers further cutting down on their costs to save money. Thus, fewer workers are hired, and there are lesser jobs available. Debt: Interest rates increase under the scenario of deflation. Therefore, it becomes riskier to borrow as the interest to be paid on borrowings increases. This leads to the situation of debt deflation wherein the real value of debt rises due to deflation. Deflationary Spiral: This refers to the scenario where lower prices lead to a further drop in prices. As prices fall, companies try to save up on their costs, leading to lower production. As a result, lower salaries are offered to the employees, and they are not able to spend on consumption. This leads to a further contraction of the economy as the demand falls, which again deflates the price levels. Is deflation more harmful than inflation? Inflation leads to an overall increase in the price levels, and thus goods become more expensive, and the value of the domestic currency falls. However, inflation may be beneficial in some cases as it helps reduce the burden of international debt. As the domestic currency loses its value, the foreign debt on a country also declines in real terms. Unlike inflation, it is hard for consumers to protect themselves from deflation. People can invest and save enough money to ensure that they can combat the scenario of inflation. However, deflation poses a set of challenges for the consumers which are hard to get by and can be explosive at times. It can also put the economy under a liquidity trap, wherein people hoard money instead of investing it. How can deflation be controlled? Deflation can be controlled by the government using the following methods: Boosting money supply: Increasing the supply of money by buying back bonds through open market operations. This would increase the value of the currency, thus leading to increased public spending. Increasing borrowing: This can be done by lowering interest rates through monetary policy. As interest rates fall, people start borrowing, thus borrowed money is put into investments and the economy is revived again. Favourable fiscal policy: Along with monetary policy changes, the central bank can also boost public spending by introducing appropriate fiscal measures. This includes tax cuts, fiscal aids and increasing public expenditure. Is deflation overall a good economic scenario for a country? Deflation can be more harmful than beneficial for an economy. If a country finds itself locked into a deflationary spiral, it becomes challenging to come out of it. Moreover, increased debt levels caused by deflation are hard to recover from, even with proper debt financing measures taken by the government. Financing debt, in the current period, may lead to increased debt burden in the future. However, lower level of prices in an economy can also have positive connotations. It can be a sign of an efficient production set up in the economy facilitated by proper utilisation of resources. Economies that offer relatively cheaper goods are deemed to be highly competitive. An example is the computer hardware markets across the world. As new and fast production techniques become accessible across the globe, the price of the final output becomes lower internationally. Thus, there is deflation in the computer hardware markets.

What is the Production Possibility Curve or PPC? A production possibility curve depicts the maximum output that can be produced in an economy with the given resources. The resources used to make these goods refer to the factors of production in the economy. PPC may sometimes also be referred to as the production possibility frontier, or PPF. PPC depicts the trade-offs faced by producers in the economy. Due to the scarcity of resources, producers must allocate these resources into the production of those goods that derive maximum welfare. For instance, consider an economy that can produce only two goods, given the resources that it is endowed with. The two goods produced are war machinery and bread. However, the producers must decide how much of each to produce. During a war, production of war equipment might increase; however, when the war ends, bread production would increase and therefore, production of war equipment must decrease because of limited availability of inputs. How is the PPF represented graphically? The above PPF represents the production possibilities in an economy that produces Good X and Good Y. A PPF would depict the trade-off between the production of only two goods at a time. Hence, a PPF can be graphically made for only two goods at a time. Point A has an allocation of 35 units of Good X and 45 units of Good Y. Similarly, point B is a combination of 50 units of Good X and 28 units of Good Y. Both these points lie on the curve and neither outside of it, nor inside of it. Thus, they are efficient and achievable allocations for this economy. Point C lies inside the PPC curve. This means that it is an inefficient allocation of resources. Point C fails to efficiently utilise the entire amount of labour, land, and capital that the economy possesses. Thus, if the resources were allocated more efficiently and used to the fullest, then the allocation would lie on the curve and not inside it. Thus, points A and B are Pareto efficient allocations as it is not possible to increase the production of Good X without decreasing the production of Good Y. Whereas, point C is not a Pareto efficient allocation as it is possible to move to an allocation that has a higher production of both Good X and Good Y. This can be achieved by moving to point A or point B. Any point lying outside the PPC curve is not attainable as the economy is not equipped with enough resources to produce that allocation of goods. Why is the PPF concave to the origin? The PPF is downward sloping because of the trade-off that exists between the production of the two goods depicted in the curve. Due to the limited availability of factor inputs, units of a good must be sacrificed to produce an additional unit of the other good. In the example of Good X and Good Y given above, moving from point B to point A increases the quantity of Good Y produced; however, this shift simultaneously decreases the quantity of Good X produced. However, this trade-off increases with the number of goods produced. Consider the following diagram: Moving from allocation A to B, the production of Good Y increases by one unit, while the production of Good X decreases by two units. Thus, two units of Good X are foregone to produce one additional unit of Good Y. Now, moving from allocation B to C, the production of Good Y increases by one unit as before; however, the production of Good X decreases by a higher volume of four units. Therefore, four units of Good X are foregone to produce one additional unit of Good Y. Thus, the marginal opportunity cost of production of Good Y goes on increasing as more and more units of Good Y are produced. More and more units of one good must be sacrificed to produce an additional unit of the other good. When does a PPC curve shift? A PPC curve may shift upwards when there is increased investment, and there is a boost to the factors of production. Alternatively, PPC may shift inwards when there is a sudden decrease in the factors of production and the production capacity falls. This may happen during a natural disaster, or a medical emergency when several lives are lost. An economy may underproduce in times of a recession. Thus, in the case of an economic slowdown, an economy might function at a point inside the PPC rather than at a point that lies on the curve. However, these shifts may also be skewed to one side depending on the good that benefits from the increase in investment or through an increase in factors of production. For instance, consider the PPC when the trade-off exists between the production of consumer goods and technological devices. When there is an advancement in the IT sector then only the technological devices would benefit from it. Thus, the PPC shift would be skewed towards the production of technological devices as shown: What does the PPC tell about the economy? A PPC only tells how much of one good must be sacrificed to produce one unit of the other good. However, it does not describe how much of both goods must be produced in the economy. Thus, producers and the government must decide on how much to produce. In a free market, the law of demand and law of supply govern the quantity of goods produced. The PPF ultimately determines the amount of supply in the economy. However, it can not determine the demand level in the economy. Therefore, PPC is one of the prime tools used in macroeconomics to determine the aggregate supply level and determine whether the economy is functioning efficiently or not.

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