What is Opportunity Cost: How Is This Related With Economic Problems

What is Opportunity Cost: How Is This Related With Economic Problems
(Last Updated On: May 17, 2020)

The Introduction Of What is Opportunity Cost & Economic Problems

People often asked “what is opportunity cost?”

Before we learn about opportunity cost, we need to first understand what exactly is meant by economic problem.

This is what we will cover in our Cambridge IGCSE and A-Levels tuition class on the very first day.

The concept of opportunity cost and economic problem are closely related.

Economic problem comprised of two components.

They are unlimited wants and limited resources.

Is there a difference between a need and want?

Of course they do.

 

Need & Want

A need is a good or service that is necessary for survival.

Example of necessities are food, water and shelter.

A want is a good or service that is NOT necessary for survival.

But rather good or service that people would like to have.

Example, we would like to have a nice big car, a big house and to go travel the world.

Do we really need those in order to continue surviving?

However, it is not wrong to ask for more than what we need.

It is just simply plain human nature to want more than we need.

Try listing down what are your needs and wants.

You will be surprise to find that there are more wants than needs.

This is the real cause of economic problems (together with limited resources).

The real cause of economic problem is the combination of unlimited wants and limited resources.

What are the resources are we referring to?

 

The Factors of Production

factors of production opportunity cost economic problem

Producer needs to produce goods and services to satisfy the need and want of their consumers.

To produce goods and services, producers need resources.

Indirectly, consumers will demand for these resources.

The resources here are often known as factors of production.

There are four factors of production.

 

#1 Land

This term refers to natural resources.

This include oil, gas, land, metals, water and other minerals.

In other words, land can be describe as raw materials needed to produce goods and services.

 

#2 Labour

This term refers to human resources.

This include factory workers that help to produce goods and services.

Both skilled and unskilled workers are in this same category.

 

#3 Capital

This term refers to man-made resources.

Basically, resources that has been “modified” or “improved”.

This include a factory, machinery and equipment needed to produce goods and services.

Is money an example of capital?

In this case, the term capital is NOT referring to money.

Is money a raw material, labour, or machinery for you to produce goods and services?

 

#4 Enterprise

This term refers to the skills, knowledge and the risk taking ability of a person who will organise the other 3 factors of production.

Remember that skills and knowledge are also a form of resources.

This person is usually known as an entrepreneur.

Example, in most cases (not all) the owner of the business is an entrepreneur.

Remember that factors of production is related directly to producers only.

 

Unlimited Want & Limited Resources: The Need to Make Choices

This is where to concept of opportunity cost comes in.

What is opportunity cost?

Opportunity cost is defined as a cost of making choices whereby the next best alternative is forgone.

We make many choices every day.

Choices such as what to eat?

What to wear?

Where to go?

How should we get there?

The concept of opportunity cost can be applied in any scenario.

In this case, let’s discuss from a consumer and producer’s point of view.

 

#1 What is Opportunity Cost? [Consumer’s Point of View]

What is the job or function of a consumer in the economy?

Their job as a consumer is to buy and consume the goods or services.

factors of production what is opportunity cost economic problem

Assuming you’re a consumer, you have 4 choices.

You have unlimited wants, obviously you will want all of them.

But you have limited resources, therefore you cannot have them all.

Assuming you picked Apple as your best choice, what is your opportunity cost?

factors of production what is opportunity cost economic problem

Most students will answer Orange, Grape and Strawberry as their opportunity cost.

WRONG!

In my own tuition classes, I asked the same question.

I always get the same wrong answer.

No worries, let’s fixed this together.

Recap the definition of opportunity cost.

Definition: The cost of making choices whereby the next best alternative is forgone.

How many “next best” can we have?

Answer is only ONE.

So how do we approach this to identify which one is the opportunity cost?

If we think carefully, before we make any decision, we must first decide which one to eliminate first.

In this case, maybe we do not want the Grape.

factors of production opportunity cost economic problem

Now we are left with 3 choices or options.

We then repeat the process to decide which one we do not want again.

Let’s say we do not want Orange.

factors of production opportunity cost economic problem

Now we are down to 2 options.

Assuming if we have decided to choose to buy Apple, what is our next best alternative?

Strawberry will be our next best alternative.

In this case, we missed the opportunity to benefit from consuming the strawberry.

Strawberry will therefore be our opportunity cost.

factors of production opportunity cost economic problem

 

#2 What is Opportunity Cost? [Producer’s Point of View]

The concept is the same as explained above.

We can only have one opportunity cost.

The job or function of a producer is to produce and sell goods and services.

Assuming now you have 3 choices to decide which to produce.

We have Durian, Mangosteen and Avocado.

factors of production opportunity cost economic problem

The same concept applies.

We need to first eliminate what we do not want to produce.

Assuming we decided not to produce Durian.

factors of production opportunity cost economic problem

We are now down to 2 choices.

If we decide to produce Avocado, our next best will be to produce Mangosteen.

factors of production opportunity cost economic problem

In short, we will not have the opportunity to benefit from producing Mangosteen.

This will be our opportunity cost as a producer.

 

What is Opportunity Cost For A Government?

Does opportunity cost theory applies for a government?

Remember this.

As long as it is a person, group of person or an organisation that is making any choices or decision, it involves opportunity cost.

Like us, government have limited resources.

Government too have unlimited wants as they try to fulfil their all objectives.

Because government have limited resources and unlimited wants, government also faces economic problem like us.

They may be deciding on whether they should spend taxpayers’ money on education, healthcare, or public transport.

factors of production opportunity cost economic problem

Assuming government decided not to proceed with Education, and decided to proceed with Public Transport.

The next best alternative that the government will have to forgo is Healthcare.

factors of production opportunity cost economic problem

 

Conclusion

Opportunity cost will occur anytime whenever a decision is to be made.

The 3 main group in the economy are the consumers, producers and government.

These 3 groups will have to deal with opportunity cost.

As long as a decision is made, opportunity cost will arise.

 

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