The need to choose
Definition
Opportunity cost: the value of the next best alternative that is given up when a choice is made.
Economic agent: any decision-maker in the economy – an individual or household, a firm or the government.
- Scarcity means that wants exceed the resources available, so no individual, firm or economy can have everything it would like.
- Because resources are limited, they cannot be used to satisfy every want at the same time.
- This forces a choice about which wants to satisfy now and which to leave unmet.
- Making a choice means selecting one option and rejecting all of the others.
- The single most valued option that is rejected is the opportunity cost of the choice.
- The same reasoning applies at three levels: individuals and households, firms, and governments.
- The scale of the decision grows from one level to the next, but the underlying logic never changes.
Key Idea
- Scarcity forces a choice, and every choice means giving up the next best alternative, which is its opportunity cost.
- The need to choose applies at every level of the economy, not only to governments.
Three levels of choice
- Individuals and households
- With limited income and time, they choose which goods and services to buy and how much to work, spend or save.
- For example, a worker with a fixed monthly income chooses between saving for a housing deposit and spending on travel, and the trip forgone is the cost of saving.
- Firms
- With limited resources and finance, they choose what to produce, how to produce it and how much to make.
- For example, a factory with a fixed number of machine hours chooses between producing chairs or producing tables, so more chairs means fewer tables.
- Governments
- With limited tax revenue, they choose how to allocate spending across competing priorities such as healthcare, education and defence.
- For example, a finance ministry with a fixed budget chooses between funding more hospitals and funding more schools.
Note
- The three levels are linked: households supply resources and demand goods, firms use resources to produce, and governments set the framework.
- A choice made at one level changes the choices available at the others.
Every choice has a cost
- At each level, choosing one option means forgoing the next best alternative.
- A household that buys a car may give up a family holiday.
- A firm that uses its capacity to make one product gives up the profit from the next best product.
- A government that funds a new hospital gives up the next best use of that money, such as new schools.
Example
- Suppose a government has a fixed budget of £10 billion and can fund only one major project.
- A new hospital would deliver benefits valued at £14 billion, a new motorway £11 billion, and a sports stadium £6 billion.
- It chooses the hospital, so the opportunity cost is the motorway, the next best alternative worth £11 billion, not the stadium and not the two rejected projects added together.
Are the levels alike?
- The logic is identical everywhere: scarcity forces a choice and every choice carries an opportunity cost.
- The objectives differ, as households aim for utility, firms aim for profit and governments weigh society-wide welfare.
- Government choices are often the hardest because they affect many people at once and involve competing aims that cannot all be met.
- So the same principle applies at all levels, even though decisions grow more complex as the level widens.
Exam technique
- State clearly which agent is making the choice: an individual, a firm or a government.
- Link the limited resource to the specific choice being made.
- Identify the opportunity cost, because that is where the analysis marks sit.
Common Mistake
- Do not think only governments have to make economic choices.
- Individuals and firms face scarcity and choose constantly, with nobody directing them in a market.
- Do not describe a choice without stating what is given up.
- A choice explained with no opportunity cost has not really been explained.
Self review
- Why does scarcity force every economy to make choices?
- Name the three levels at which economic choices are made.
- Give one example of a choice made by a household, a firm and a government.
- What links a choice made at one level to the choices at another?
- Why are government choices often the most difficult?
