IGCSE Economics: The Basic Economic Problem — Revision Notes

Condensed for the final weeks. For the full explanation, use the The Basic Economic Problem study guide.

Scarcity

Wants are unlimited; resources are limited. That is the basic economic problem, and every other idea in the syllabus follows from it.

Because resources are scarce, choices must be made, and every choice has an opportunity cost.

Three questions every economy must answer: what to produce, how to produce it, for whom to produce it.

Opportunity cost

The next best alternative forgone when a choice is made.

Not the total of everything given up — only the single best alternative. Government examples: spending on a hospital means a school forgone. Consumer: buying a phone means the holiday forgone. Producer: making more of good A means less of good B.

Note that a free good (air, in most contexts) has no opportunity cost because it is not scarce. Almost everything else is an economic good.

Worked example — free good vs economic good. Air is a free good — unlimited in supply, with no opportunity cost and no price. Oil is an economic good — scarce relative to demand, so obtaining it has an opportunity cost and it commands a price. The test is never “does it cost money at the till” but whether resources had to be sacrificed to produce or extract it.

Factors of production

Factor	Meaning	Reward
Land	All natural resources	Rent
Labour	Human physical and mental effort	Wages
Capital	Man-made goods used to produce other goods	Interest
Enterprise	Organising the other three and bearing risk	Profit

Capital means machinery, tools and factories, not money. Money is used to buy capital; it is not itself a factor of production. This is examined every series.

Production possibility curves

A PPC shows the maximum combinations of two goods an economy can produce when all resources are fully and efficiently employed.

Point	Meaning
On the curve	Full and efficient employment
Inside	Unemployment or inefficiency — resources are being wasted
Outside	Unattainable with current resources and technology

Moving along the curve shows opportunity cost: gaining more of one good requires giving up some of the other.

Shifting the curve outwards shows economic growth, caused by:

• More or better resources — new discoveries, immigration of workers
• Improved technology
• Better education and training raising productivity
• More investment in capital goods

A shift inwards results from war, natural disaster, or a fall in the labour force.

The curve is normally drawn concave to the origin because resources are not equally suited to both uses, so opportunity cost rises as more of one good is produced.

Two distinct kinds of growth on a PPC. A permanent increase in productive capacity is shown by an outward shift of the whole curve, caused by more or better resources or improved technology. Short-run growth can also occur simply by moving from a point inside the curve towards it, using existing idle resources more fully, with no change in what the economy is capable of producing at maximum — this movement is temporary and reversible if resources fall idle again, unlike a genuine shift.

Capital goods versus consumer goods is the standard question: producing more capital goods today means less consumption now, but shifts the PPC further out in future — sacrificing present consumption for future growth.

Economic sectors

• Primary — extracting raw materials: farming, mining, fishing, forestry.
• Secondary — manufacturing and construction.
• Tertiary — services: retail, banking, tourism, transport.

As countries develop, the primary sector shrinks and the tertiary sector grows.

Exam traps

• Saying opportunity cost is “everything you give up” rather than the next best alternative.
• Calling money a factor of production.
• Saying a point inside the PPC is unattainable — it is attainable but inefficient.
• Confusing a movement along the PPC (reallocation) with a shift (growth).
• Forgetting that a PPC assumes resources are fully employed.
• Giving examples without linking them back to scarcity or choice.

Self-test

1. State the basic economic problem in one sentence.
2. Define opportunity cost and give a government example.
3. Name the four factors of production and their rewards.
4. What does a point inside the PPC indicate?
5. Give three causes of an outward shift in the PPC.
6. Explain why air is a free good but oil is an economic good.
7. Distinguish between a movement towards a PPC and an outward shift of the whole PPC.

Answers: 1. Wants are unlimited but resources are limited, so choices must be made. 2. The next best alternative forgone; for example, government spending on a new hospital means a new school is forgone. 3. Land–rent, labour–wages, capital–interest, enterprise–profit. 4. Unemployment or inefficiency — the economy is not using all its resources fully, so output could be increased without any opportunity cost. 5. More or better resources, improved technology, better education and training raising productivity, or greater investment in capital goods — any three. 6. Air is unlimited in supply, so obtaining it requires no sacrifice of resources and it has no opportunity cost; oil is scarce relative to demand, so extracting it has an opportunity cost. 7. A movement towards the curve uses existing idle resources more fully and is temporary and reversible; an outward shift is a permanent increase in what the economy is capable of producing at maximum, caused by more or better resources or improved technology.