<1.6 CLASSIFICATION OF GOODS & SERVICES>

"Why is water usually much cheaper than diamonds, even though water is essential for life?

The answer lies in scarcity relative to demand. In most places, water is abundant relative to the amount people want, whereas diamonds are much scarcer relative to demand. As a result, the marginal value of an additional unit of water is often lower than the marginal value of an additional diamond, leading to a lower market price.

This observation highlights one of the most important ideas in economics:

Economics is the study of how societies allocate scarce resources that have alternative uses.

If a good is not scarce relative to demand, there is no need to make choices about how it should be allocated. Such goods are known as free goods and generally fall outside the central focus of economics because they do not create an economic problem.

For this reason, economists are primarily interested in economic goods—goods and services that are scarce relative to demand and therefore have an opportunity cost.

"Why is it that when group work is set, some of you wince?" "Is it because you can't exclude the lazy 'free-riding' members of the group from sharing equally in the grade that only you worked for?", "If the teacher didn't insist on it, how many of you would only ever work alone?"