IGCSE Economics 0455 – The Basic Economic Problem: Opportunity Cost
The Basic Economic Problem – Opportunity Cost
Every economy faces the fundamental problem of scarcity: resources (land, labour, capital, entrepreneurship) are limited, but human wants are unlimited. Because of scarcity, individuals, firms and governments must make choices about how to allocate resources. The cost of any choice is the opportunity cost – the value of the next best alternative that is foregone.
Definition of Opportunity Cost
Opportunity cost can be expressed mathematically as:
\$\$
OC = \frac{\text{Benefit of the next best alternative}}{\text{Cost of the chosen option}}
\$\$
In words, it is the benefit you give up when you select one option over another.
Decision‑Making by Different Economic Agents
1. Consumers
Consumers decide how to spend their limited income.
When a consumer buys a pizza for \$5, the opportunity cost is the next best item they could have bought with that \$5 (e.g., a sandwich).
Consumers compare marginal benefit (additional satisfaction) with marginal opportunity cost.
2. Workers (Labour)
Workers allocate their time between work, leisure, education and other activities.
If a worker chooses to study for an extra hour, the opportunity cost is the wage they could have earned by working that hour.
Decision rule: work the hour if the wage earned > the value placed on the alternative use of time.
3. Producers / Firms
Firms decide how to use scarce factors of production to produce goods and services.
When a firm uses a machine to produce bicycles, the opportunity cost is the number of scooters that could have been produced with that same machine.
Firms aim to produce where marginal revenue exceeds marginal opportunity cost.
4. Government
Governments allocate public resources (tax revenue, land, labour) among health, education, defence, infrastructure, etc.
If the government spends $1 billion on a new highway, the opportunity cost is the health services that could have been funded with that money.
Public‑sector decisions often involve weighing social benefits against opportunity costs.
Comparative Summary
Economic Agent
Resource Being Allocated
Typical Decision
Opportunity Cost Example
Consumer
Income
What to purchase
Choosing a pizza → foregone sandwich
Worker
Time
Work vs. leisure vs. study
Studying an hour → foregone wage
Producer/Firm
Factors of production (land, labour, capital)
Which product to produce
Using a machine for bicycles → foregone scooters
Government
Tax revenue, public land, public labour
Allocation to public services
Building a highway → foregone health spending
Key Points to Remember
Opportunity cost is always measured in terms of the next best alternative.
It applies to all economic agents – not just individuals.
Decision‑making involves comparing marginal benefits with marginal opportunity costs.
In a market economy, prices help signal opportunity costs, but governments must often estimate them directly.
Suggested diagram: Production Possibility Frontier (PPF) showing opportunity cost of moving from point A (more of good X) to point B (more of good Y). The slope of the PPF at any point represents the opportunity cost of X in terms of Y.