Scarcity and Opportunity Cost
This section focuses on scarcity, choice and opportunity cost, which the exam tests through definitions, PPF calculations and decisions by consumers, firms and governments. You must be able to calculate opportunity cost from a table or PPF and explain why every choice has a cost.
Core rules
- Scarcity means limited resources relative to unlimited wants. It is universal and forces choice.
- A shortage is a market situation where quantity demanded exceeds quantity supplied at a price; it can disappear when price rises. Scarcity cannot be eliminated by price changes.
- Free goods have no opportunity cost, such as air in normal conditions. Economic goods are scarce and have opportunity cost.
- Opportunity cost is the value of the next best alternative forgone. It is not necessarily a money payment.
- Sunk costs are already incurred and cannot be recovered, so they should not affect a new decision.
- With a concave PPF, opportunity cost rises as more of a good is produced because resources are not equally suited to both uses.
Worked example
A farmer has 10 hectares and can grow rice or beans. Option A: 30 tonnes rice, 0 beans. Option B: 20 tonnes rice, 10 tonnes beans. Moving from A to B loses 10 tonnes rice and gains 10 tonnes beans, so the opportunity cost of 1 tonne beans is 1 tonne rice. If the farmer instead moves from B to C: 10 tonnes rice, 18 tonnes beans, the next 8 tonnes of beans cost 10 tonnes of rice, so each tonne of beans costs 1.25 tonnes of rice. This illustrates increasing opportunity cost.
Traps
Do not count sunk costs as opportunity cost; do not confuse scarcity with shortage; do not assume opportunity cost is always money; do not ignore the next best alternative when calculating cost.