Scarcity, choice and opportunity cost

Economics AS · Basic economic ideas and resource allocation. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

Resources are limited but human wants are unlimited. This gap is scarcity, the fundamental economic problem. It affects everyone: individuals have limited income and time, firms have limited funds, and governments have limited budgets. Even a very rich person has only 24 hours in a day.

Because of scarcity, a choice must be made whenever a resource has alternative uses. Every choice means something else is given up. The opportunity cost is the next best alternative given up, not all the alternatives added together.

Every economy must therefore answer three questions: what to produce, how to produce it, and for whom to produce it.

Rules to remember

Scarcity: limited resources compared with unlimited wants.
Opportunity cost: the next best alternative forgone when a choice is made.
Choices are made at all levels: individuals, firms and governments.
What to produce: which goods and services, and how much of each.
How to produce: which mix of labour, capital and other resources to use.
For whom to produce: who receives the output, which depends on the distribution of income.
If the resources used would otherwise be unemployed, the opportunity cost of using them is very low.

Common mistake

Students add up all the rejected options, or give the money price paid. Opportunity cost is only the single best alternative that was given up.

Worked example

A town council has one empty plot of land. Its options, in order of preference, are a clinic, a primary school and a car park. It builds the clinic. What is the opportunity cost?

The land can be used only once, so choosing the clinic means the other uses are lost.
Opportunity cost is the next best alternative, so look at the option ranked second.
The second choice is the primary school. The car park is ranked third, so it would not have been chosen anyway.

Answer: The opportunity cost is the primary school.

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