The Central Problem of Economics


In economics, the basic problem is one that discusses limited resources but unlimited ones. This is known as scarcity. This suggests that at any point of time, the economy cannot consume beyond a given point and every action incurs opportunity cost (cost in terms of the next best alternative foregone). This suggests that people must make economic decisions that maximize their welfare.


With reference to diagram, the line shows the maximum production capacity of producing the products. At any given time, the economy can produce 100 units of capital goods or 200 units of consumer goods, but not both. This explains for the basic problem of scarcity, for example there is limited labor or technology in the country at this point of time. Hence for the economy to consume beyond their initial capacity, they must increase their factor inputs (land, labor, capital) to increase capacity to PPC2. It is possible for the economy to consume less than their maximum capacity, this happens when not all resources are utilized (for example, some people are not working). This means they consume at point E or D, which is less than the maximum capacity.

The diagram also shows the concept of opportunity cost, which is the cost in terms of the next best alternative foregone. This can be seen from points A and B. If producers decided to use produce more capital goods (and hence spend more resources on them), then they give up the available resources that could be used to produce consumer goods. Consider the points A and B, as economy produces more consumer goods at point B, they gave up capital goods which is the opportunity cost incurred.

This suggests that consumers and producers have to make choices that best maximize their economic welfare or utility.

-by Quintessential Education

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