Understanding the Challenge of Resource Allocation

Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught history, and has an MA in Islamic law/finance. He has since founded his own financial advice firm, Newton Analytical.

How scarce something is and how useful it is to someone is fundamental to how economies allocate resources. Learn why economists place so much significance on scarcity and utility and identify the three main standards, or philosophies, of resource allocation. Understanding scarcity and utility is key to understanding the challenge of resource allocation. Explore why resources are allocated, how resources are allocated, systems for allocating resources in this lesson. Updated: 10/09/2021

Scarcity and Utility

At its core, economics is nothing more than the study of scarcity, a word economists use to describe the fact that no resource is infinite. Take a minute to let that really sink in. Everything is limited in quantity. This makes the most sense when faced with something that we can really understand as being limited, like Babe Ruth rookie cards or jewelry, but it is a lot harder to accept when you look at something we treat largely as limitless, like air or water. But think about what happens when we start to treat water or air as limitless resources. We end up with pollution, which limits the usefulness of the remaining resource.

The concept of scarcity means that economists never forget that there are limits on everything. However, to go along with that scarcity is the idea of utility. Utility is a measure of how useful something is. Economists assume that humans allocate their resources in a rational manner in order to gain the greatest utility possible.

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  • 0:01 Scarcity and Utility
  • 1:17 Allocating Resources
  • 3:18 Systems for Allocation
  • 4:35 Lesson Summary
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Allocating Resources

Needless to say, one person's utility may not be someone else's. If you own a steel mill, acquiring raw iron is of much greater utility than it is to someone who owns a dairy farm. Likewise, hay may be relatively useless to you, but for the dairy farmer, it is vital as feed for the cows. However, that difference in utility is not the only real difficulty that is faced when allocating resources. A central concern is making sure that we are producing as much of a good as possible. All sorts of things limit our ability to produce goods that may be beyond our immediate control. If a new technology to increase steel production hasn't been invented yet, then I can't very well be expected to use it in producing steel. Likewise, if a new factory hasn't been built yet, I can't be expected to use it.

However, this makes controlling those factors that we can shape even more important. For a steel mill owner, this could mean any number of things. Most obviously, you can't make steel if you don't have iron to turn into steel. However, all the iron in the world won't do you any good without electricity to power the machinery, workers to operate the factory, or quality machines to transform the iron into steel. We can thus see that major concerns in avoiding inefficiency include supplies of raw materials and utilities, working technology, and labor supply. And, of course, you have to have money to pay for everything. All of this effort to make sure that resources are efficiently allocated is called, oddly enough, allocative efficiency.

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