Cambridge IGCSE Economics 0455 – The Basic Economic Problem: Producers/Firms
The Basic Economic Problem – The Nature of the Problem for Producers
1. What is the basic economic problem?
Resources (land, labour, capital and entrepreneurship) are scarce, but human wants are unlimited.
Consequently, producers must decide how to allocate limited resources to produce the goods and services that will generate the greatest benefit.
2. Why does the problem arise for firms?
Scarcity of inputs: A firm cannot obtain unlimited amounts of raw materials, skilled workers or capital equipment.
Opportunity cost: Using a resource for one purpose means it cannot be used for another. The cost of the foregone alternative is the opportunity cost, expressed as \$OC = \text{value of next best alternative}\$.
Limited market demand: Even if a firm could produce more, there may be insufficient demand to sell the extra output.
3. Examples of the basic economic problem for producers
3.1 Choice of product mix
A small bakery has a limited amount of flour, ovens and staff time each day. It must decide how many loaves of bread, pastries and cakes to produce.
If it produces more bread, fewer pastries can be made, potentially losing customers who prefer sweets.
The opportunity cost of an extra loaf of bread is the number of pastries that could have been produced with the same flour and labour.
3.2 Allocation of capital equipment
A textile firm can purchase either a new loom or a new dyeing machine. Both cost $150,000 and the firm has only enough capital for one.
Assess expected increase in output: the loom could raise cloth production by 20 %.
Assess expected increase in value added: the dyeing machine could increase profit per unit by 15 %.
Choose the option with the higher expected net benefit, recognising the foregone benefit of the alternative.
3.3 Use of labour
A fast‑food restaurant has 10 employees on a shift. It must decide how many staff to assign to the kitchen versus the drive‑through.
More kitchen staff can speed up food preparation, reducing waiting time.
Fewer drive‑through staff may increase queue length, causing customers to leave.
The opportunity cost of assigning an employee to the kitchen is the lost service speed at the drive‑through.
3.4 Production versus research and development (R&D)
A smartphone manufacturer can allocate $5 million to increase current‑model production or to fund R&D for a new model.
The decision involves comparing:
Immediate revenue from higher sales of the existing model.
Future revenue and market share from a successful new model.
The opportunity cost of investing in production is the potential future profit from the new model, and vice‑versa.
4. Summary Table – Key Elements of the Basic Economic Problem for Firms
Element
Explanation
Typical Example
Scarce Resources
Limited inputs such as land, labour, capital, entrepreneurship.
Only 100 kg of steel available for a car manufacturer.
Choice
Selecting one use of a resource over another.
Deciding between producing trucks or buses.
Opportunity Cost
Value of the next best alternative foregone.
\$OC = \text{profit from producing buses if trucks are not produced}\$.
Efficiency
Maximising output or profit from the given resources.
Using the optimal mix of labour and machinery to minimise unit cost.
Suggested diagram: Production Possibility Frontier (PPF) for a firm showing trade‑offs between two products (e.g., Product A and Product B). The slope illustrates the opportunity cost of producing more of one product.
5. Key Points to Remember
The basic economic problem exists for every firm because resources are limited.
Every decision involves a trade‑off and an associated opportunity cost.
Firms aim to allocate resources efficiently to maximise profit or achieve other objectives.
Understanding the nature of scarcity helps explain why firms must prioritize certain activities over others.