Basic Economic Ideas & Resource Allocation

The economic problem

Scarcity is the central economic problem: human wants are unlimited but resources are finite. Because we cannot satisfy every want, we must choose how to allocate scarce resources. Every choice involves a sacrifice.

Opportunity cost is the value of the next best alternative forgone when a choice is made. It applies to consumers (spend on a phone vs a holiday), firms (build a factory vs invest the cash) and governments (spend on health vs defence).

A free good has no opportunity cost (no resources used to obtain it, e.g. air in most settings). An economic good is scarce and so has an opportunity cost.