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Scarcity, choice and opportunity cost: Class 11 Economics
The meaning of economics, scarcity and choice, the basic economic problems, opportunity cost, the production possibility curve and the main kinds of economic system.
Key points
Economics is the study of how people, firms and governments use limited resources to satisfy unlimited wants. Human wants have no end. The resources that satisfy them are limited. This gap between wants and resources is the problem of scarcity, and it exists in every country, rich or poor.
Resources are the factors of production:
- Land: all natural resources, such as soil, water, minerals and forests. Its reward is rent.
- Labour: the physical and mental work of people. Its reward is wages.
- Capital: man-made goods used in production, such as machines and buildings. Its reward is interest.
- Enterprise (entrepreneurship): the organisation of the other factors and the willingness to take risk. Its reward is profit.
Because of scarcity every society must make choices. Choosing one thing means giving up another. The opportunity cost of a choice is the value of the next best alternative that is given up. If a farmer uses a field to grow wheat instead of sugarcane, the opportunity cost of the wheat is the sugarcane that could have been grown.
The three basic economic problems that every society must solve:
- What to produce, and in what quantities.
- How to produce: which resources and methods to use.
- For whom to produce: how the output is shared among people.
The production possibility curve (PPC), or production possibility frontier, shows the maximum combinations of two goods that an economy can produce with all its resources fully and efficiently used. A point on the curve is efficient. A point inside the curve means resources are unemployed or wasted. A point outside is not possible with the present resources and technology.
The PPC is usually bowed outwards from the origin. This shows increasing opportunity cost: as more of one good is produced, larger and larger amounts of the other good must be given up, because resources are not equally good at making both goods. An economy grows when more resources or better technology move the whole curve outwards.
Economic systems answer the three basic questions in different ways:
- In a market (capitalist) economy, private owners and the price system decide, and the government has a small role.
- In a planned (command) economy, the government owns the resources and decides what, how and for whom to produce.
- In a mixed economy, the private sector and the government both have a role. Pakistan has a mixed economy.
Economics is divided into microeconomics and macroeconomics. Microeconomics studies the decisions of individual consumers, firms and markets, such as the price of wheat. Macroeconomics studies the whole economy, such as national income, inflation and unemployment. Positive statements can be tested against facts (Inflation was 9 % last year). Normative statements express opinions or value judgements (The government should reduce inflation).
Study tip: For an opportunity cost question, name the choice that was made, name the best alternative that was given up, and state clearly that this alternative is the cost.
Definitions and flashcards
Say the meaning first, then open the card to check.
Scarcity
The shortage of resources compared with the wants of people.
Opportunity cost
The value of the next best alternative given up when a choice is made.
Factors of production
Land, labour, capital and enterprise.
Production possibility curve
A curve that shows the maximum output combinations of two goods.
Mixed economy
An economy in which the private sector and the government both take part in decisions.
Microeconomics
The study of individual markets and decision makers.
Macroeconomics
The study of the economy as a whole.
Positive statement
A statement of fact that can be tested.
Short questions with model answers
These are the kind of questions asked for 2, 3 and 5 marks. Try each one before opening the answer.
Define scarcity and explain why it leads to choice. (3 marks)
Scarcity is the shortage of resources in relation to unlimited human wants. Because resources cannot satisfy every want, people, firms and governments must choose which wants to satisfy and which to give up.
What is opportunity cost? Give an example. (3 marks)
It is the value of the next best alternative that is given up. If a student spends Saturday studying instead of playing cricket, the opportunity cost of studying is the enjoyment of the cricket match.
List the four factors of production and their rewards. (4 marks)
Land earns rent, labour earns wages, capital earns interest and enterprise earns profit.
What does a point inside the production possibility curve show? (2 marks)
It shows that some resources are unemployed or not used efficiently, so the economy is producing less than it could.
Distinguish between a positive and a normative statement. (2 marks)
A positive statement is a statement of fact that can be tested, such as The price of petrol rose last month. A normative statement is an opinion or value judgement, such as Petrol should be cheaper.
Common mistakes
- Saying that opportunity cost is the money paid. It is the value of the best alternative given up.
- Counting every alternative as the opportunity cost. Only the next best one counts.
- Confusing capital in economics (machines and buildings) with money.
- Drawing a PPC that is a straight line without saying that this means constant opportunity cost.
- Mixing up microeconomics and macroeconomics.