Basic Concepts
Scarcity
Society has limited resources and cannot produce all the goods and services people wish to have. A universal problem, not limited to poor nations. All products that have a price are relatively scarce.
Choice
Because resources and income are limited while wants are unlimited, individuals and society must choose how to allocate their scarce resources among alternative uses.
Trade-Off
Giving up some of one thing to get more of another.
Opportunity Cost
Measure of a trade-off. Choosing one option means the resource used (time, money, land) cannot be used on another. The opportunity cost of the chosen option is the value of the single best alternative given up, not the sum of all alternatives given up, and not the money price.
For example: a field can produce either 10 tons of wheat or 8 tons of corn in a season. Planting wheat has an opportunity cost of 8 tons of corn.
Marginal Benefit
The additional benefit gained from consuming or producing one more unit of a good or service.
For example: the satisfaction from eating a second slice of pizza, or the extra revenue from selling one more unit.
Marginal Cost
The additional cost incurred from producing one more unit of a good or service.
For example: the cost of ingredients and labor for one more pizza, or the extra electricity to run a machine for one more hour.
Rational People
A rational decision maker compares marginal benefit and marginal cost, and acts only if the marginal benefit exceeds the marginal cost.
Marginal Change
A small incremental adjustment to a plan of action.
Factors of Production
A factor of production is a resource used to produce goods and services. Its return is the payment earned for supplying it.
Land
All natural resources used in production. Renewable and non-renewable. Return: rent.
Labour
Physical and mental effort of human beings used in production. Return: wages.
Capital
Man-made aids to further production. Return: interest.
Entrepreneurship
Managing, organizing, and planning the other three factors, and bearing risk. Return: profit.
Goods
Economic Good
Uses scarce resources in its production, so its marginal cost is greater than zero.
For example: a paper clip, a smartphone, a haircut, a textbook.
Free Good
Does not require scarce resources, so its marginal cost is zero.
For example: air, sunlight, rainwater, a public park view.
Types of Products in an Economy
Consumer Goods
Purchased and consumed directly by individuals and households.
- Durable
Appliances, cars, furniture, laptops. - Non-durable
Food, clothing, toiletries, gasoline.
Capital Goods
Also known as producer or intermediate goods. Used by businesses to produce other goods and services.
For example: machinery, equipment, factories, infrastructure, delivery trucks, 3D printers, industrial robots.
Services
Intangible actions provided to meet a need, leaving no physical product. Consumed at the time of production.
For example: healthcare, education, transport, consulting, streaming subscriptions, cloud storage, legal advice.
Worked Examples
Opportunity Cost of Working
Surani can work and earn Rs. 100,000, or study and receive a scholarship worth Rs. 500,000. Find the opportunity cost of choosing to work.
Solution Reveal Hide
The opportunity cost is the value of the best alternative given up.
Choosing to work gives up studying, which is worth Rs. 500,000.
The opportunity cost is Rs. 500,000.
