The basic economic problem of scarcity and choice

The basic economic problem of scarcity and choice

The Basic Economic Problem

  • Scarcity is the fundamental economic problem of having seemingly infinite human wants and needs in a world with finite resources.
  • Economists refer to this issue as the problem of scarcity and choice, which arises because resources are scarce relative to the wants and needs they could be used to satisfy.
  • As a result of scarcity, choices have to be made about how to allocate and utilise these scarce resources most efficiently.

Economic Choices

  • Individuals, firms, and governments must all make decisions about how to allocate their resources to best meet their objectives.
  • Individual choices often involve questions about what to buy and when, considering issues such as price, personal tastes and incomes.
  • Firms have to choose what to produce, how much to make, and where and when to sell their products.
  • Governments have to make choices on how to use their revenues, balancing the many competing demands for spending.

Opportunity Cost

  • Because of scarcity and the need for choice, whenever we make a decision, we incur an opportunity cost, the next-best alternative we forgone.
  • In other words, the opportunity cost of any action is the value of the highest-value alternative action that could have been taken instead.
  • The concept of opportunity cost allows economists to examine the relative monetary costs of good, services, actions and decisions.

Production Possibility Frontier (PPF)

  • The Production Possibility Frontier (PPF) is a graph that shows the different rates of production of two goods that an economy can produce efficiently during a specified period of time.
  • The PPF assumes that all inputs are used efficiently. As more of one product is produced, an increasing amount of the other product must be sacrificed, which illustrates the concept of opportunity cost.
  • Points on the PPF are efficient, points inside are feasible but inefficient, and points outside the PPF are unattainable with the current levels of resources.
  • The PPF can shift outwards if there are improvements in productivity, increases in the quantity and quality of resources, or technological advances.

Trade-Offs and Allocative Efficiency

  • Trade-offs occur when the use of resources in one way prevents their use in another way.
  • Making decisions about trade-offs is a matter of comparing the costs and benefits of different choices.
  • The most efficient allocation of resources occurs when no further change could make someone better off without making someone else worse off – this is known as allocative efficiency.