The basic economic problem - Opportunity cost (3)
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1.
Suppose a country is deciding whether to allocate more resources to producing consumer goods or capital goods. Explain, using the concept of opportunity cost, the factors that the government should consider when making this decision.
The government should consider the opportunity cost of allocating resources to either consumer goods or capital goods. Opportunity cost in this context is the potential benefit forgone by not allocating resources to the alternative.
Factors to consider:
- Current level of economic development: A developing country might benefit more from investing in capital goods (e.g., factories, infrastructure) to boost long-term productivity, even if it means fewer consumer goods are available immediately. The opportunity cost of not investing in capital goods is slower economic growth.
- Consumer demand: If consumer demand for goods is high, the opportunity cost of not producing those goods might be significant (e.g., social unrest, lower political support).
- Availability of resources: The availability of raw materials and skilled labor will influence the potential returns from both consumer and capital goods production. The opportunity cost of choosing one over the other must consider resource constraints.
- Inflation: High inflation can erode the value of capital investments, making the opportunity cost of investing in capital goods higher.
- Government priorities: The government's overall policy goals (e.g., reducing unemployment, improving living standards) will influence the decision. The opportunity cost must be weighed against these priorities.
2.
Explain how the concept of opportunity cost can be used to illustrate the trade-offs involved in economic decision-making. Provide an example to support your answer.
Opportunity cost highlights the fundamental trade-offs inherent in all economic decisions. Because resources are scarce, choosing to use them for one purpose necessarily means foregoing the opportunity to use them for something else. This trade-off is the essence of opportunity cost.
Example: A business owner has £100,000 to invest. They can either invest it in new equipment to increase production or use it to market their existing products.
- If the owner chooses to invest in new equipment, the opportunity cost is the potential increase in sales and profits they could have achieved by investing in marketing.
- Conversely, if the owner chooses to invest in marketing, the opportunity cost is the potential increase in production and profits they could have achieved by investing in new equipment.
This illustrates that every economic decision involves a sacrifice. The business owner must weigh the potential benefits of each option and choose the one that provides the greatest net benefit, considering the forgone alternative.
3.
Define opportunity cost in economic terms. Illustrate your answer with a relevant example.
Opportunity cost is the value of the next best alternative forgone when making a choice. It represents what you give up when you choose one option over another. It's not simply the monetary cost, but the benefit you could have received from the alternative.
Example: Imagine a student has 5 hours to study for exams. They can choose to study for Economics, Biology, or Chemistry. If they choose to study for Economics, the opportunity cost is the potential improvement in grades they could have achieved by studying Biology or Chemistry instead. The student forgoes the benefit of those other subjects to focus on Economics.