The basic economic problem
Wants are unlimited but resources are finite, so every economy faces scarcity and must make choices. Choices have an opportunity cost, which a production possibility curve can show.
📌 Key points
- The basic economic problem is that wants are unlimited but resources are finite, so there is scarcity and choices must be made.
- Every economy must decide what to produce, how to produce it and for whom to produce it.
- An economic good is scarce and has an opportunity cost; a free good (such as air) is not scarce and has no opportunity cost.
- The four factors of production are land, labour, capital and enterprise; their rewards are rent, wages, interest and profit.
- Capital is a human-made good used to produce other goods and services, such as machines, tools, vehicles and factories.
- The quantity and quality of factors can change: e.g. labour rises with population growth, immigration or a higher retirement age, and improves with education and training.
- Factors can be geographically mobile (able to move place) or occupationally mobile (able to change job); low mobility can cause unemployment.
- Opportunity cost is the next best alternative forgone when a choice is made; consumers, workers, firms and governments all face it.
- A production possibility curve (PPC) shows the maximum combinations of two products an economy can make when all its resources are fully and efficiently used.
- Points on the PPC are efficient, points inside it show unused or inefficiently used resources, and points outside it are unattainable; an outward shift shows economic growth.
📖 Key terms
- Scarcity
- The situation where there are not enough resources to satisfy all wants.
- Opportunity cost
- The next best alternative forgone when a choice is made.
- Factors of production
- The resources used to produce goods and services: land, labour, capital and enterprise.
- Enterprise
- The willingness to take risks and organise the other factors of production; its reward is profit.
- Free good
- A good that is not scarce, so it has no opportunity cost.
- Production possibility curve
- A curve showing the maximum output combinations of two products using all resources efficiently.
- Microeconomics
- The study of individual markets and decision makers such as households, workers and firms.
- Macroeconomics
- The study of the whole economy, e.g. inflation, unemployment and economic growth.
✏️ Worked example
An economy can produce 100 cars and 0 tractors, or 60 cars and 20 tractors. Calculate the opportunity cost of producing the 20 tractors, and of one tractor.
- Opportunity cost is what has to be given up: here, cars.
- Car output falls from 100 to 60, so 100 − 60 = 40 cars are given up.
- So the opportunity cost of 20 tractors is 40 cars.
- Per tractor: 40 ÷ 20 = 2 cars.
- Answer: 40 cars in total, or 2 cars for each tractor.
Opportunity cost is only the next best alternative, not every alternative and not the money spent. Name the specific thing given up.
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