Examples of the basic economic problem in the context of producers/firms

The Basic Economic Problem – The Nature of the Problem for Producers (Firms)

1. What the syllabus calls “the basic economic problem”

• Scarcity (definition from the Cambridge syllabus): Resources are limited in quantity relative to the unlimited wants of people.
• Unlimited wants: Human desire for goods and services never ceases.
• Three fundamental questions that every decision‑maker must answer:

  1. What goods and services should be produced?
  2. How should they be produced (which techniques and inputs are used)?
  3. For whom should they be produced (who receives the output)?

2. Why the problem arises for firms

• Scarcity of inputs: A firm cannot obtain unlimited quantities of land, labour, capital or entrepreneurship.
• Opportunity cost: Using a resource for one purpose means it cannot be used for the next best alternative.

  
  Verbal formula: OC = value of the next best alternative.

  
  Numeric formula on a PPC: OC = ΔQ_B ÷ ΔQ_A (the amount of good B given up when output of good A is increased by one unit).

• Limited market demand: Even if a firm could produce more, there may be insufficient demand to sell the extra output.

3. Factors of production and their rewards (Cambridge IGCSE 0455)

Note on factor mobility (syllabus requirement): Labour is mobile – workers can move between firms, industries or locations in search of better pay or conditions. Capital is also mobile to a degree, as owners can invest in different projects or relocate equipment.

4. Production Possibility Curve (PPC) – Key concepts for firms

• Points on the curve: Efficient – the firm uses all its scarce resources fully.
• Points inside the curve: Inefficient – some resources are idle or under‑utilised.
• Points outside the curve: Unattainable with the current resource base.
• Movement along the curve: Shows the trade‑off (opportunity cost) between two products.
• Shift of the curve: Caused by a change in the quantity or quality of resources (e.g., new technology, more skilled labour, loss of raw material).

5. Illustrative examples of the basic economic problem for producers

5.1 Choice of product mix – a bakery

The bakery has a fixed daily supply of flour, oven capacity and staff hours. It must decide how many loaves of bread, pastries and cakes to produce.

• More bread → fewer pastries, potentially losing customers who prefer sweets.
• Opportunity cost of an extra loaf of bread = number of pastries that could have been produced with the same flour and labour.

5.2 Allocation of capital equipment – a textile firm

The firm can purchase either a new loom or a new dyeing machine, each costing $150 000, but it only has enough capital for one.

1. Expected output increase: loom → 20 % more cloth.
2. Expected value‑added increase: dyeing machine → 15 % higher profit per unit.
3. Choose the option with the higher net benefit, recognising the foregone benefit of the alternative as the opportunity cost.

5.3 Allocation of labour – a fast‑food restaurant

Ten employees are on a shift. Management must decide how many to assign to the kitchen versus the drive‑through.

• More kitchen staff speeds food preparation, reducing waiting time.
• Fewer drive‑through staff may lengthen queues, causing customers to leave.
• Opportunity cost of assigning an employee to the kitchen = lost service speed (and possible sales) at the drive‑through.

5.4 Production versus research and development (R&D) – a smartphone maker

The company can allocate $5 million to increase current‑model production or to fund R&D for a new model.

• Production option: Immediate revenue from higher sales of the existing model.
• R&D option: Future revenue and market‑share gains if the new model succeeds.
• Students should carry out a simple cost‑benefit analysis. The opportunity cost of the production route is the foregone future profit from the new model, and vice‑versa.

5.5 Hiring an extra worker versus training the existing workforce – a clothing manufacturer

The firm has the budget to either hire one more seamstress or to provide a two‑day training course for its current staff.

• Hiring a seamstress adds immediate capacity – e.g., 30 extra shirts per week.
• Training raises skill levels, potentially increasing productivity of all workers by 10 %.
• Opportunity cost of hiring = the extra output that could have been generated by a 10 % productivity boost across the existing workforce.

6. Summary table – Key elements of the basic economic problem for firms

7. Context box – The basic economic problem is common to all decision‑makers

While this note focuses on firms, the same scarcity logic applies to:

• Households: Choosing between consumption today and saving for future consumption.
• Workers: Deciding how many hours to work versus leisure.
• Government: Allocating tax revenue between health, education, defence, etc.

Each group faces limited resources, unlimited wants, and must answer the three basic questions listed in section 1.

8. Key points to remember

• The basic economic problem exists for every firm because resources are limited while wants are unlimited.
• Every decision involves a trade‑off and an associated opportunity cost, which can be expressed verbally or numerically on a PPC.
• Firms aim to allocate scarce resources efficiently to maximise profit (or achieve other objectives such as market share).
• Recognising scarcity explains why firms must prioritise certain activities over others and why the PPC shifts when resources change.