Economics: Scarcity and Opportunity Cost

• Economics is the study of how to allocate scarce resources in order to satisfy unlimited wants and needs

Scarcity

• Scarcity exists because resources are limited, but human wants are unlimited
• Scarcity forces choices to be made about how to use resources
• Resources include natural resources (land, minerals), human resources (labor), and capital resources (machinery, equipment)

The Basic Economic Questions

• Due to scarcity, every economy must answer three fundamental questions:
  • What to produce? Which goods and services should be produced and in what quantities?
  • How to produce? How should goods and services be produced? Which production methods and technologies should be used?
  • For whom to produce? How should the goods and services be distributed among the population? Who gets what?

Opportunity Cost

• Opportunity cost is the value of the next best alternative that is forgone when a choice is made
• Because resources are scarce, every decision involves an opportunity cost
• It represents the potential benefits you miss out on when choosing one alternative over another

Production Possibility Curves (PPC)

• A PPC illustrates the maximum combinations of two goods or services that can be produced with a given amount of resources and technology, assuming full and efficient use of those resources
• Points on the curve represent efficient levels of production
• Points inside the curve represent inefficient use of resources
• Points outside the curve are unattainable with current resources and technology
• The shape of the PPC reflects opportunity cost; a bowed-out PPC indicates increasing opportunity costs

Economic Systems

• An economic system is the way a society organizes the production, distribution, and consumption of goods and services
• The main types of economic systems are:
  • Market economy: Resources are allocated primarily through the price mechanism, driven by supply and demand
  • Command economy: Resources are allocated by a central authority (usually the government)
  • Mixed economy: A combination of market and command elements; most modern economies are mixed

Market Economy

• Key characteristics include:
  • Private ownership of resources
  • Free markets and prices guide resource allocation
  • Consumer sovereignty (consumers' wants determine what is produced)
  • Profit motive drives firms
  • Competition among businesses
• Advantages:
  • Efficiency: Resources are generally allocated to their most valued uses
  • Innovation: Competition encourages firms to develop new products and processes
  • Choice: Consumers have a wide variety of goods and services to choose from
• Disadvantages:
  • Inequality: Can lead to large disparities in income and wealth
  • Market failures: Can result in monopolies, pollution, and under-provision of public goods
  • Instability: Prone to economic fluctuations (booms and busts)

Command Economy

• Key characteristics:
  • State ownership of resources
  • Central planning determines resource allocation
  • Limited consumer choice
  • Minimal competition
• Advantages:
  • Greater equality: Can distribute income and wealth more evenly
  • Stability: Can avoid some of the fluctuations of market economies
  • Provision of public goods: Can ensure that essential services like healthcare and education are available to all
• Disadvantages:
  • Inefficiency: Central planning is difficult and often leads to misallocation of resources
  • Lack of innovation: No incentive for firms to develop new products or processes
  • Limited choice: Consumers have few goods and services to choose from

Mixed Economy

• Combines elements of both market and command economies
• Government intervention in the market aims to correct market failures, promote social welfare, and ensure stability
• The degree of government intervention varies significantly across mixed economies
• Most countries today operate with a mixed economy system