Economic Systems, Maslow's Hierarchy, and Opportunity Cost
Economic Systems of Resource Allocation
There are two primary systems of resource allocation, representing different forms of organization to answer fundamental economic questions:
- System of Authority: The state or a central entity makes the decisions.
- Market System: The market and prices respond to the three basic economic questions.
Maslow's Hierarchy of Needs
Human requirements appear in succession, starting with the most elementary, physiological types. As one level is satisfied, higher-level, more psychological needs emerge. Access to higher-level needs depends on an individual's comfort level. While all people have basic needs, this does not guarantee the attainment of self-actualization.
Furthermore, the order in which Maslow ranked these needs is not completely rigid, as some individuals may prefer to sacrifice basic needs for higher-order ones:
- Physiological needs: The first to appear in humans; satisfaction is critical to survival.
- Security needs: These emerge once physiological needs are relatively satisfied.
- Membership/Social needs: These lead the individual to interact with other members of society.
- Esteem needs: People require self-respect and the appreciation of others.
- Need for self-realization: Fulfilling one's own potential.
Opportunity Cost and Decision Making
Choice implies selecting how to use resources to meet specific needs rather than all of them. This leads to the concept of opportunity cost (or alternative cost).
Every decision carries a "cost," as satisfying one need means sacrificing others. The opportunity cost is the value of the best option sacrificed, not the sum of all alternatives.
Example of Opportunity Cost
Consider a plot of 20 hectares with the following annual income options:
- Alternative 1: Livestock - $5 million
- Alternative 2: Fruit trees - $6 million
- Alternative 3: Wheat - $7 million
- Alternative 4: Lease for a club - $2.5 million
If you decide to plant fruit trees, the opportunity cost of that decision is $7 million—the income you would have earned had you chosen to grow wheat instead.
Economic Models
Economics is based on models—conceptual representations of complex systems that omit less relevant variables to simplify analysis.
Circular Flow Model
The circular flow model is a simple way to visualize the economic transactions that occur between families and businesses within an economy.
Production Possibilities Frontier
The production possibilities frontier is a graph showing various combinations of output that an economy can produce, given its factors of production and technology.