Examples of the basic economic problem in the context of consumers

Basic Economic Problem – Consumers (Cambridge IGCSE Economics 0455)

1. What the syllabus expects

• Define scarcity, economic goods, free goods and unlimited wants.
• Explain why scarcity creates the basic economic problem for consumers.
• Describe the three inter‑related consumer decisions: what to buy, how much to buy and from whom to buy.
• Show how opportunity cost, trade‑offs and marginal utility influence those decisions.
• Use a budget line (budget constraint) and indifference curves to illustrate consumer choice.
• Apply the concepts to real‑world situations and answer typical exam questions.

2. Key definitions (Cambridge wording)

3. Why scarcity creates the basic economic problem for consumers

Because every consumer has a limited amount of resources (money, time, skills) but faces unlimited wants, they must constantly decide how to allocate those scarce resources. This necessity to choose – and the fact that choosing one option means giving up another – is the basic economic problem for consumers.

4. The three consumer decisions and the trade‑off

1. What to buy – which goods or services will best satisfy their wants.
2. How much to buy – the quantity that maximises satisfaction given the budget.
3. From whom to buy – which supplier, brand or source offers the best value.

Each decision involves a trade‑off: choosing more of one good means having less of another, or spending time on one activity means losing the chance to do something else.

5. Opportunity cost and trade‑offs

• Opportunity cost (OC) = the value of the *next best alternative* that is foregone when a choice is made. (No division by units is required.)
• It measures the real cost to the consumer of any decision.

Illustrative examples

• Spending £50 on a pair of shoes instead of a £50 concert ticket: OC = the concert experience.
• Using 3 hours of free time to watch a film that could have been spent on a part‑time job earning £30: OC = £30 of income.

6. Utility and marginal utility

• Utility – total satisfaction a consumer derives from a bundle of goods.
• Marginal utility (MU) – additional satisfaction from consuming one more unit of a good.
• Law of diminishing marginal utility – MU falls as more units of a good are consumed.
• Consumers aim to maximise total utility by allocating spending so that:
  MU₁ / P₁ = MU₂ / P₂ = … = MUₙ / Pₙ

7. Budget constraint (budget line)

• Shows all combinations of two goods that a consumer can afford with a given income and given prices.
• Formula: Income = P₁·Q₁ + P₂·Q₂
• Slope = –(P₁ / P₂) – the rate at which one good can be exchanged for the other.
• Intercepts:
  • Q₁‑intercept = Income / P₁ (when Q₂ = 0)
  • Q₂‑intercept = Income / P₂ (when Q₁ = 0)
• Shifts:
  • Increase in income → parallel outward shift.
  • Change in price of one good → pivot around the intercept of the other good.

Quick sketch checklist (exam)

1. Label axes (good 1 on the x‑axis, good 2 on the y‑axis).
2. Mark the two intercepts and draw a straight line between them.
3. Write the slope as –P₁/P₂.
4. Show a parallel shift for a change in income or a pivot for a price change.
5. Indicate the chosen point (if required) on the line.

8. Indifference curves

• Represent bundles of goods that give the consumer the same level of satisfaction (utility).
• Properties required by the syllabus:
  • Downward sloping.
  • Higher curves represent higher satisfaction.
  • Do not cross.
  • Convex to the origin (reflects a diminishing marginal rate of substitution).
• Marginal Rate of Substitution (MRS) = the rate at which a consumer is willing to give up good 2 for an extra unit of good 1 while remaining on the same indifference curve.
• Consumer equilibrium occurs where the highest attainable indifference curve is tangent to the budget line, i.e.:
  MRS = P₁ / P₂

Quick sketch checklist (exam)

1. Draw a downward‑sloping, convex indifference curve.
2. Draw the budget line on the same axes.
3. Show the point of tangency – label it as the equilibrium bundle.
4. State the condition MRS = P₁/P₂.

9. Real‑world examples of the basic economic problem for consumers

• Budget constraint: A university student has £300 per month for living expenses. Paying £120 for a gym membership leaves £180 for rent, food and social activities.
• Time scarcity: A parent has 12 free hours each weekend. Spending 5 hours on grocery shopping leaves only 7 hours for family outings or extra paid work.
• Product shortage: During a chip shortage a consumer must decide whether to buy an available but expensive model now or wait for the preferred model at a lower price later.
• Quality‑quantity trade‑off: With £50 for weekly food, buying organic produce (higher quality) reduces the number of different items compared with buying a larger quantity of standard produce.
• Choice of supplier: When buying a laptop, the consumer compares a high‑street retailer (higher price, immediate delivery) with an online seller (lower price, longer delivery, different warranty).

10. Sample tables – consumer choices and their opportunity costs

11. Suggested diagrams (for classroom or exam answers)

12. Summary checklist (quick revision)

• Scarcity = limited resources + unlimited wants.
• Economic goods have a price; free goods do not.
• Consumers must decide what, how much and from whom to buy – each decision involves a trade‑off.
• Opportunity cost = value of the next best alternative.
• Budget line: Income = P₁Q₁ + P₂Q₂; slope = –P₁/P₂; parallel shift = income change; pivot = price change.
• Indifference curves: downward, higher = more satisfaction, never cross, convex to the origin.
• Consumer equilibrium: highest attainable indifference curve tangent to the budget line → MRS = P₁/P₂.
• Utility maximisation condition: MU₁/P₁ = MU₂/P₂ = …
• Real‑world examples help illustrate trade‑offs, scarcity and opportunity cost.

13. How to use these notes for exam practice

1. Read each heading and write a short answer in your own words – this checks understanding of the syllabus language.
2. Redraw the budget‑line and indifference‑curve diagrams from memory. Use the quick‑sketch checklists to ensure you label axes, intercepts, slope, MRS and the tangency point.
3. Create a personal table of three choices, identify the opportunity cost for each, and link the trade‑off to utility or budget‑line concepts.
4. Practice a past‑paper question that asks you to “explain why the basic economic problem exists for consumers”. Include:
   • a definition of scarcity and unlimited wants,
   • the three consumer decisions,
   • an example of opportunity cost, and
   • a brief reference to the budget line or indifference curves.