Edexcel IGCSE Economics Your notes

The Economic Problem

Contents
The Nature of the Economic Problem
Opportunity Cost
Production Possibility Curves

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 The Nature of the Economic Problem
Your notes
The Basic Economic Problem: Scarcity
The basic economic problem is that resources are scarce
In economics, these resources are called the factors of production
There are finite resources available in relation to the infinite wants and needs that
humans have
Needs are essential to human life, e.g. shelter, food, and clothing
Wants are non-essential desires, e.g. better housing, a yacht, etc.
Due to the problem of scarcity, choices have to be made by producers, consumers,
workers and governments about the best (most efficient) use of these resources
E.g. Should the resources (land) be used to provide housing, which is an essential
need, or rather allocated towards creating a beautiful park (want)
Economics is the study of scarcity and its implications for resource allocation in society
All Stakeholders in an Economy face the Basic Economic Problem

Consumers Producers Workers Government

In a free Producers Workers may Governments have

market, selling products want a more to decide if they
scarcity has made from comfortable will provide certain
a direct scarce and safer goods/services or
influence on resources will working if they will allow
prices find their costs environment private firms to
of production but their provide them
The scarcer are higher than if employers may instead
a resource or they were not have the
product, the selling products resources to Their decision
higher the made from create it influences the
price more abundant allocation of
consumers resources resources in
will pay society

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 Opportunity Cost
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Opportunity Cost Defined
Opportunity cost is the loss of the next best alternative when making a decision
Due to the problem of scarcity, choices have to be made about how to best allocate
limited resources amongst competing wants and needs
There is an opportunity cost in the allocation of resources
When a consumer chooses to purchase a new phone, they may be unable to
purchase new jeans. The jeans represent the loss of the next best alternative (the
opportunity cost)
When a producer decides to allocate all of their resources to producing electric
vehicles, they may be unable to produce petrol vehicles. The petrol vehicles
represent the loss of the next best alternative (the opportunity cost)
When a government decides to provide free school meals to all primary students in
the country, they may be unable to fund some rural libraries which may have to
close. The libraries represent the loss of the next best alternative (the opportunity
cost)

Opportunity Cost in Decision Making

An understanding of opportunity cost may change many decisions made by
consumers, workers, firms and governments
Factoring the opportunity cost into a decision often results in different outcomes and so
a different allocation of resources
Examples of how the Consideration of Opportunity Costs can Change Decisions

Stakeholder Example

Consumer Ashika is wanting to visit her best friend in Iceland

She looks at flight prices from London to Reykjavík
On Friday night it costs £120, whereas Thursday night is only £50
She is about to book the Thursday flight but then realises that the
opportunity cost of saving £60 on a flight is the inability to work on
Friday (loss of £130 income)
Ashika books the more expensive flight. If she had booked the
cheaper flight, it would have cost her the income from the missed day
of work (£130) + £50 for the ticket

Producer A firm selling organic avocados is offered a supply contract by a large

supermarket that wants to buy all of their stock each month, but at a

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 low price
The supermarket is a prestigious customer
Your notes
The firm decides not to accept the contract as the opportunity cost
(loss of prestigious customer) is worth less than the lost revenue to
existing customers

The Australian Government has entered into a contract with France to

supply them with 8 submarines valued at $70 billion
Government
The USA hears about it and pressurises Australia to buy the submarines
from them instead
The Australian Government considers the opportunity cost of
denying the USA, which includes less preferential deals on other
military hardware and general trade agreements
They decide to break the contract with France and view this as the
approach that carries the lowest opportunity cost

Examiner Tips and Tricks

Opportunity cost is about the loss of the next best alternative. It is not a monetary
amount. Money may well be a factor, but opportunity cost is about the loss of the next
best choice when making a decision.

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 Production Possibility Curves
Your notes
An Introduction to the PPC
The Production Possibility Curve (PPC) is an economic model that considers the
maximum possible production (output) that a country can generate if it uses all of its
factors of production to produce only two goods/services
Any two goods/services can be used to demonstrate this model
Many PPC diagrams show capital goods and consumer goods on the axes
Capital goods are assets that help a firm or nation to produce output
(manufacturing). For example, a robotic arm in a car manufacturing company is a
capital good
Consumer goods are end products and have no future productive use. For
example, a watch

Diagram: Production Possibility Curve (PPC)

A PPC for an economy demonstrating the use of its resources to produce capital or
consumer goods

Diagram analysis
The use of PPC to depict the maximum productive potential of an economy
The curve demonstrates the possible combinations of the maximum output this
economy can produce using all of its resources (factors of production)

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 At A, its resources are used to produce only consumer goods (300)
At B, its resources are used to produce only capital goods (200) Your notes
Points C and D both represent full (efficient) use of an economy's resources, as
these points fall on the curve. At C, 150 capital goods and 120 consumer goods are
produced
The use of PPC to depict opportunity cost
To produce one more unit of capital goods, this economy must give up production
of some units of consumer goods (limited resources)
If this economy moves from point C (120, 150) to D (225, 100), the opportunity cost
of producing an additional 105 units of consumer goods is 50 capital goods
A movement in the PPC occurs when there is any change in the allocation of
existing resources within an economy, such as the movement from point C to D

Examiner Tips and Tricks

You may be asked to draw the production possibility curve (PPC) to show a change in
the combination of two goods . Make sure to fully label both axes and use arrows to
indicate increase/decrease of two goods

PPC & Economic Growth

As opposed to a movement along the PPC described above, the entire PPC of an
economy can shift inward or outward

Diagram: Shifts in PPC

Outward shifts of a PPC show economic growth & inward shifts show economic decline

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Diagram analysis
Economic growth occurs when there is an increase in the productive potential of an Your notes
economy
This is demonstrated by an outward shift of the entire curve. More consumer goods
and more capital goods can now be produced using all of the available resources
This shift is caused by an increase in the quality or quantity of the available factors
of production
One example of how the quality of a factor of production can be improved is
through the impact of training and education on labour. An educated
workforce is a more productive workforce and the production possibilities
increase
One example of how the quantity of a factor of production can be increased is
through a change in migration policies. If an economy allows more foreign
workers to work productively in the economy, then the production possibilities
increase
Economic decline occurs when there is any impact on an economy that reduces the
quantity or quality of the available factors of production
One example of how this may happen is to consider how the Japanese tsunami of
2011 devastated the production possibilities of Japan for many years. It shifted
their PPC inwards and resulted in economic decline

Increasing Versus Constant Opportunity Cost

Two different types of opportunity cost can be illustrated using PPC curves
Constant opportunity cost occurs when all of the factors of production used to
produce one good can be switched to producing the other good without any
loss/wastage of resources
One unit given up one of good results in one unit gained of the other
Increasing opportunity cost occurs when the factors of production cannot be perfectly
switched between the two products
One unit given up of one good results in less than one unit gained of the other

Diagram: Increasing Versus Constant Opportunity Cost on

PPC

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 Your notes

There is a constant opportunity cost between the production of T-shirts and hoodies. But
increasing opportunity cost when moving production between consumer and capital
goods

Diagram analysis
For a country producing only T-shirts and hoodies, the factors of production can easily
be switched between the two products e.g. the same labour and land (cotton) can be
used to make both products
Changing production from point F to G decreases the production of T-shirts from 4
to 3 and increases the production of hoodies from 3 to 4
There is constant opportunity cost when production is switched
For a country producing consumer goods and capital goods, the factors of production
cannot easily be switched between the two products e.g. the labour required to make a
washing machine may not have the skill to produce a robotic arm used in car
manufacturing
Changing production from point A to point C results in a decrease of 130 consumer
goods but yields an increase of 180 capital goods
Changing production from point C to point B results in a decrease of 120 consumer
goods but only yields an increase of 20 capital goods
There is an increasing opportunity cost as production moves closer and closer to
any particular axis

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