basic questions of resource allocation

Scarcity, Choice and Opportunity Cost

1. Why study scarcity?

Scarcity is the fundamental economic problem: limited resources (land, labour, capital, entrepreneurship) must satisfy unlimited human wants. Because resources are scarce, societies must decide how to allocate them efficiently.

2. Key concepts

• Scarcity: Fewer resources than the total amount of wants.
• Choice: Selecting one alternative and forgoing others when resources are insufficient.
• Opportunity cost: The value of the next best alternative given up when a choice is made. Expressed as a trade‑off (e.g., “units of B per unit of A”).
• Marginal decision‑making: Compare the additional (marginal) benefit of one more unit of a good with its marginal opportunity cost.
• Time dimension: Opportunity costs can differ in the short‑run (some inputs fixed) and the long‑run (all inputs variable).

3. Economic methodology

Aspect	Positive statement	Normative statement
Definition	Describes what *is*; can be tested and proved false.	Prescribes what *ought to be*; involves value judgments.
Example	“A rise in the price of wheat reduces the quantity demanded.”	“The government should keep wheat prices low to protect consumers.”

Ceteris paribus (“all else equal”) is used to isolate the effect of one variable while holding others constant. Economic models are simplified representations that help us understand complex real‑world behaviour; assumptions are made explicit so their impact can be evaluated.

4. Factors of production

• Land – natural resources (e.g., oil fields, farmland).
  Reward: rent.
• Labour – human effort (physical and mental).
  Reward: wages.
• Capital – man‑made goods used to produce other goods (machinery, factories, software).
  Reward: interest (or profit on capital assets).
• Enterprise (entrepreneurship) – risk‑taking, organisation and innovation.
  Reward: profit.

Example: In a smartphone factory, land is the factory site, labour is the assembly line workers, capital includes the robots and tools, and the entrepreneur coordinates the process and bears the risk.

5. Resource allocation in different economic systems

Economic system	How resources are allocated
Market (price) economy	Decisions made by households and firms through the price mechanism; supply and demand determine quantities and prices.
Planned (command) economy	Central authority (government) decides what, how and for whom to produce; resources are allocated by directives.
Mixed economy	Both market forces and government intervention influence allocation; e.g., private firms operate alongside publicly provided services.

Case study (health‑care): The UK National Health Service (NHS) is largely publicly funded and provided (planned element), whereas the United States relies heavily on private insurers and providers (market element). Both systems aim to meet the “for whom” question but use different allocation mechanisms.

6. Decision‑making at the margin (step‑by‑step)

1. Identify the problem or need.
2. List all feasible alternatives (individual, firm or government level).
3. Estimate the marginal benefit (MB) and marginal cost (MC) of each alternative.
4. Calculate the marginal opportunity cost (ensure the same unit of output is used for both goods).
5. Choose the alternative with the greatest net marginal benefit (or the lowest marginal opportunity cost).

7. Calculating opportunity cost

When a given set of resources can produce either Good A or Good B, the opportunity cost of one unit of A is the amount of B that could have been produced with those same resources.

Formula (unit‑consistent):

$$\text{Opportunity Cost of 1 A} = \frac{\text{Maximum output of B}}{\text{Maximum output of A}} \;\; \text{(units of B per unit of A)}$$

Note: Numerator and denominator must refer to the same time‑period and the same resource bundle.

8. Numerical example – a small island economy

The island has 1,000 labour‑hours per week. Each hour can be used either for fishing or for coconut production.

• 1 labour‑hour → 5 fish
• 1 labour‑hour → 3 coconuts

Let \(L_F\) be labour‑hours used for fishing and \(L_C\) for coconuts. The capacity constraint is:

$$L_F + L_C = 1{,}000 \quad (\text{labour‑hours})$$

If the island allocates 600 h to fishing and 400 h to coconuts:

$$\text{Fish} = 600 \times 5 = 3{,}000 \text{ units}$$ $$\text{Coconuts} = 400 \times 3 = 1{,}200 \text{ units}$$

The marginal opportunity cost of producing one additional coconut is:

$$\text{OC}_{\text{coconut}} = \frac{5\ \text{fish per hour}}{3\ \text{coconuts per hour}} = \frac{5}{3}\ \text{fish} \approx 1.67\ \text{fish}$$

Thus each extra coconut costs the island about 1.67 fish that could have been caught with the same hour of labour.

9. The three basic questions of resource allocation

1. What to produce? – Determines the mix of goods and services.
2. How to produce? – Chooses the techniques, inputs and organisational structure.
3. For whom to produce? – Decides the distribution of output among individuals and groups.

It is also useful to ask who decides – the market (price mechanism) or a central planner (government). These questions apply at three levels of the economy:

• Individuals/households – what to consume, how much to work.
• Firms – what to produce, which production technique to use.
• Government – provision of public goods, taxation and welfare policies.

10. Production Possibility Curve (PPC)

• Definition: A graph showing the maximum possible output combinations of two goods that can be produced with a fixed amount of resources and technology.
• Shape:
  • Straight line – constant opportunity cost.
  • Bow‑shaped (concave to the origin) – increasing opportunity cost as production shifts from one good to the other.
• Key points on the curve:
  • Efficient (productive efficiency) – any point on the curve (e.g., point A).
  • Inefficient – any point inside the curve (e.g., point B).
  • Unattainable – any point outside the curve with current resources (e.g., point C).
• Shifts of the PPC:
  • Outward shift – increase in resources, improvement in technology, or better organisation.
  • Inward shift – war, natural disaster, or depletion of resources.
• Slope – the marginal opportunity cost of the good on the horizontal axis expressed in units of the good on the vertical axis.

11. Opportunity‑cost table (illustrative)

Production choice	Units of Good X	Units of Good Y	Opportunity cost of 1 X (Y)	Opportunity cost of 1 Y (X)
All resources to X	150	0	–	0 X per Y
All resources to Y	0	300	0 Y per X	–
Mixed production	90	180	2 Y per X	0.5 X per Y

12. Forward‑looking links

• The concepts of scarcity, choice and opportunity cost underpin the Production Possibility Curve (Topic 1.5).
• Understanding opportunity cost helps classify goods as normal, inferior, luxury, public, private (Topic 1.6).
• Economic methodology (positive vs. normative, ceteris paribus) is the foundation for analysing market equilibrium, welfare economics and macro‑economic models later in the syllabus.

13. Summary

Scarcity forces every society to make choices at the margin. Each choice entails an opportunity cost – the value of the next best alternative that must be given up. By applying marginal analysis, students can answer the fundamental resource‑allocation questions (what, how, for whom) and understand who makes those decisions (market versus planner). Mastery of these concepts provides the analytical base for later topics such as the Production Possibility Curve, classification of goods, and the broader economic methodology used throughout the Cambridge IGCSE/A‑Level syllabus.