Examples of the basic economic problem in the context of governments

The Basic Economic Problem

1.1 Nature of the basic economic problem

All societies face scarcity: the factors of production (land, labour, capital and enterprise) are limited, whereas human wants are unlimited. Because of scarcity every economy must answer three fundamental allocation questions – exactly as the Cambridge IGCSE syllabus states:

• What goods and services should be produced?
• How should they be produced? (choice of techniques and combination of factors)
• For whom are they produced? (distribution of output)

The syllabus also distinguishes between two types of goods:

• Economic goods – scarce items that have a price (e.g., a smartphone, a bus ticket).
• Free goods – abundant items that are not scarce and have no price (e.g., air, sunlight in most circumstances).

1.2 Factors of production and their rewards

Quantity and quality of factors affect both the level of output and the size of the rewards:

• Quantity: Discovery of new mineral deposits increases the quantity of land; building more factories raises the quantity of capital.
• Quality: Training programmes improve the skill level of labour; research and development upgrades the quality of capital equipment; better management raises the quality of enterprise.

1.3 Opportunity cost

Opportunity cost is the value of the next best alternative that is foregone when a choice is made.

Influence of opportunity cost on decision‑making

• Consumers – Choosing a cinema ticket means the money cannot be used to buy a new jacket.
• Workers – Doing overtime for extra pay means giving up leisure time with family.
• Producers – Using a factory to make bicycles means the same factory cannot produce scooters at the same time.
• Governments – Spending £1 billion on road building means that £1 billion is unavailable for health‑care improvements.

Diagrammatic illustration (draw and label)

1.4 Production‑possibility curve (PPC)

The PPC is a graphical model that shows the maximum combinations of two goods or services an economy can produce when all resources are fully and efficiently employed.

How to draw a PPC (step‑by‑step)

1. Label the vertical axis with one good (e.g., Health services).
2. Label the horizontal axis with the other good (e.g., Education).
3. Mark a point representing the maximum output of health services when no education is produced.
4. Mark a point representing the maximum output of education when no health services are produced.
5. Connect the two points with a smooth, bowed‑out curve – this is the PPC.
6. Label three points:

   • A – on the curve (efficient production).
   • B – inside the curve (inefficient/under‑utilised resources).
   • C – outside the curve (unattainable with current resources).

Interpretation of points

• On the curve – All resources are fully employed; the economy is operating efficiently.
• Inside the curve – Resources are idle (unemployment, under‑used factories) → inefficiency.
• Outside the curve – Production is currently impossible given the existing resource base.

Movement along the PPC

Moving from one point on the curve to another shows a trade‑off. The opportunity cost is the amount of the good on the vertical axis that must be given up to gain more of the good on the horizontal axis.

Numerical example: Suppose point A represents 8 million units of education and 4 million units of health. Moving to point B (10 million units of education, 3 million units of health) means the economy gives up 1 million health units to gain 2 million education units. The opportunity cost of 1 million additional education units is 0.5 million health units.

Shifts of the PPC

Any change that alters the quantity or quality of the factors of production, or introduces new technology, shifts the entire curve.

• Outward shift (economic growth) – caused by:

  • Increase in the quantity of factors (e.g., discovery of new oil reserves, more labour entering the workforce).
  • Improvement in the quality of factors (e.g., better‑educated labour, upgraded machinery, more skilled entrepreneurs).
  • Technological advancement (e.g., automation, new production methods).

• Inward shift (contraction) – caused by:

  • Loss of factor quantity (e.g., natural disaster destroys farmland, emigration of skilled workers).
  • Decline in factor quality (e.g., ageing workforce, obsolete equipment).
  • Negative technological change or loss of know‑how.

Examples of the basic economic problem in the context of governments

Governments at all levels must allocate scarce public resources to meet competing societal needs. The following examples illustrate scarcity, choice and opportunity cost in public decision‑making.

1. Budget allocation – A national government has a fixed tax revenue of £R. Raising the health budget means less money is available for defence, education or infrastructure. The forgone benefits constitute the opportunity cost.
2. Public housing vs. environmental protection – A local authority owns a limited parcel of land. Using part of it for affordable housing reduces the area that could be set aside for parks, flood‑defence schemes or nature reserves.
3. Infrastructure investment – Choosing to build a new highway instead of upgrading a railway line involves a trade‑off between reduced road congestion and the potential increase in rail capacity, lower emissions and long‑term sustainability.
4. Social‑welfare programmes – Expanding unemployment benefits requires either higher taxes, additional borrowing, or cuts to other services; each alternative has its own economic consequences.
5. Emergency response after a disaster – Deciding how much of the emergency fund to spend on immediate relief (food, shelter) versus long‑term reconstruction (housing, infrastructure) illustrates opportunity cost.

Comparative table of government choices