Scarcity, choice and opportunity cost

Overview

Three fundamental questions every economy must answer, why scarcity is not the same thing as a shortage and why opportunity cost applies to individuals.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   State the basic economic problem and explain why it exists in every society.

   Model answer

   The basic economic problem is that human wants are unlimited while the resources available to satisfy them are limited. Because no society has enough land, labour, capital and enterprise to produce everything everyone wants, every society must decide what to produce, how to produce it and for whom. The problem is universal because it follows from the gap between wants and resources, not from poverty or bad organisation.

2. 2

   What are the three fundamental questions every economy must answer?

   Model answer

   Every economy must decide what to produce, meaning which goods and services and in what quantities; how to produce, meaning which combination of factors and which techniques to use; and for whom to produce, meaning how the output is distributed among the population. Different economic systems answer these questions in different ways, but no system can avoid them.

3. 3

   Explain why scarcity is not the same thing as a shortage.

   Model answer

   Scarcity is the permanent condition that resources are insufficient to satisfy all wants, and it applies even to a very rich economy. A shortage is a temporary market situation in which the quantity demanded exceeds the quantity supplied at the prevailing price, and it can be removed by a price rise. Diamonds are scarce but there is normally no shortage of them, because the price is high enough to clear the market.

4. 4

   Define opportunity cost and explain why it is measured in terms of one alternative rather than all of them.

   Model answer

   Opportunity cost is the value of the next best alternative forgone when a choice is made. It is measured against the single best alternative because that is what was actually given up: once the chosen option is taken, only one other option could have been taken instead. Adding together every rejected option would exaggerate the sacrifice, since they could not all have been enjoyed at once.

5. 5

   A student has one free evening and could revise, work a paid shift worth £45, or see friends. She revises. What is the opportunity cost?

   Model answer

   The opportunity cost is whichever of the two rejected options she valued most highly. If she would otherwise have worked the shift, the opportunity cost is the £45 of earnings plus anything else that shift would have provided. It is not £45 plus the value of seeing friends, because only one alternative could have been chosen.

6. 6

   A government spends £900 million on a new hospital. Explain the opportunity cost of the decision to two different groups.

   Model answer

   For the government the opportunity cost is the best alternative use of the £900 million, such as the schools, roads or tax cuts that must now be forgone. For the wider society the opportunity cost is the real resources absorbed: the builders, engineers, steel and machinery used on the hospital cannot be used elsewhere, so other construction projects are delayed. Money cost is the accounting figure; opportunity cost is the alternative output given up.

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