Gr.

12 Scarcity, choice and opportunity cost

Meaning of Economics

One of the most quoted definitions of Economics today is perhaps, “Economics is a science
which studies human behavior as a relationship between ends and scarce means which have
alternative uses.”. This Definition was given by Lionell Robbins in 1935.

If we put in simple words, Economics is the study of human bahaviour in relation to their wants.
It studies how human beings manage their scare resources in trying to satisfy their wants.

Scarcity

Scarcity means limitation of the availability of resources in relation to their wants. That means
the available resources are not enough to completely satisfy all the wants.

By now, you must have already learnt that human beings have unlimited wants. And as the
resources with which these wants must be satisfied are limited, we can understand that
‘scarcity’ is the central economic problem of everyone including individuals, firms and the
government, and even the whole world.

Opportunity Cost

If we decide and choose which want to satisfy with the available resource, then there are other
wants we have to leave unsatisfied. We have to forgo something in order to satisfy a want. The
want that is forgone is called the ‘opportunity cost’. It is also known as ‘the next best alternative’.

The concept of scarcity, choice and opportunity cost can be shown in many ways, at different
levels. For an individual, it may involve choosing the best from the choices available. For
example, a student may have to choose between doing A levels and going for a diploma right
after finishing O levels. Choosing one option means the other option has to be forgone.

A firm may have to choose between different production methods.

A government may have to choose between different development projects.

Inevitability of choices

Each and every level of economic agent (individuals, firms or government) has to make the
choices as all of them are confronted with central economic problem (scarcity). Governments
have to decide on the best possible way to allocate resources (example – where and what kind
of factories must be built), the firms have to decide how to maximize profit (what is the most
efficient way to produce goods) and individuals have to decide how to maximize their welfare
(which goods will give them most satisfaction). In the process of making this choice they have to
give up other alternative so the concept of opportunity cost is applicable for each and every
level of economic agents.
The basic economic questions

There are some basic questions faced by every society. How they are answered depends
largely on the type of economic system the country has. The questions are:

What to produce?

What to produce primarily depends on consumers in free market. The consumers choose the
product they like and thus their choices direct the types of production that should be carried out.
The firms will follow this because this is the most profit maximizing combination.

Sometimes the government too can decide what to produce. The government may decide to
produce an essential good or service which everyone ought to have.

How to produce?

This question will be answered by those supplying the goods and services. If the supplier is a
private firm, it will seek to use the method which will give the maximum profit. For example,
production can be done using labour intensive method and capital intensive method. The private
firm will decide on the method which will give lowest average costs.

If the government is the supplier, it may try to use the method which promotes welfare of the
society rather than maximising the profit.

For whom to produce?

For whom to produce will also depend on the suppliers (government and private firms). The
consumers are the target of production, but the kind of consumers the firm or the government
wants to target is the question. The government usually produces for the general public where
as the private firms can seek to maximize profit by producing for the high and rich level
customers as well as the general public. In simple words, the production is done for those who
are willing to pa

Note: among the suppliers, there will also be private individuals(sole traders). Their objective in
production is the same as that of the private firms – that is, to maximise profit.

short run, long run, very long run

In the perspective of an individual firm, the short-run is when at least one of its factors of
production is fixed. Therefore, there will be a limit to the extent to which it will be able to respond
to an increase in price.

However, firms will try and increase their capacity by increasing all their factors of production,
which means all the factors of production can become variable. This is known as the long-run.
Therefore, the long run is the time which is taken by a firm to change all of its factors of
production.
In the very long run, not only all of a firm’s factors of production are variable, but also all the
inputs which are beyond the control of the firm. During the very long run, not only are the labor,
capital, land, and entrepreneurship inputs variable, but so too are key production inputs such as
government rules, technology, and social customs.

Different allocative mechanisms

As the countries try to allocate their resources, they are faced with the questions of what, how
and for whom to produce. The answer to these questions determine what type of an economic
system a particular country has.

Market Economies

Command Economies

Mixed Economies

Market Economies

Market Economies is also known as capitalist economies. In this type of economic system, the
questions facing the economy is answered by the forces of demand and supply.

What to produce – What the customer demands.

How to produce – By private companies, the companies decide the most efficient method and
competes with each other to win customers.

For whom to produce – The production is done for those who demand. It is for the customers
willing to pay money to buy the produced goods and services.

Price/ market mechanism which manipulates the allocation of resources or tries to resolve the
three fundamental questions of what, how and for whom to produce. In other words, resources
are allocated through changes in relative prices. Adam Smith referred to it as the “invisible
hands” of the market.

Producers aim at profit maximisation and rely on higher prices as a “green signal” to higher
production. The foundation is the profit motive. Evidently, the production of those commodities
will be more profitable which are demanded more by consumers. There is freedom of choice for
producers and consumers.

Everyone in a market economy acts in self-interest. The factors of production are owned by
private individuals and companies. Government has a very minimal role in the production.

Advantages of market system

Market system automatically responds and adjusts to the people’s wants

As we know, in a market system, the price of goods and services are determined by the forces
of demand and supply. If consumers want a particular good or a service, they simply demand
for it and the prices go up, which gives signal for the producers to produce more of that good. If
producers can produce the required amount of that particular good, the price automatically
comes down to normal. Likewise, if people no longer wants a particular good, they simply stop
demanding for it, so that it is no longer profitable for producers to produce that good, so
producers stop producing that good.

Wider variety of goods and services

In a market system, producers compete with each other by offering wider variety of goods,
therefore consumers have more choice, this may even lead to lower prices.

Competition pushes businesses to be efficient: keeping costs down and production high.

The aim of firms in a market economy is to make as much profits as possible. In order to do this,
the firms need to be more efficient. Therefore they often use new and better methods for
production, this leads to lower costs and higher output.

Government does not have to take decisions on basic economic questions

The market system relies on producers and consumers to decide on what, how and for whom to
produce. Therefore it does not require the government to employ a group of people to take
these decisions

The disadvantages of market system

Factors of Production is not employed if it is not profitable

In a market system, producers do not produce a good or a service if it is not profitable. But
sometimes it may be necessary to produce some goods even if it is not profitable. Therefore
Market system will fail in this aspect.

Market system may not produce certain goods and services

Private firms in a market system will not be willing to provide certain public goods like street
lights because it is almost impossible to charge any payment from the consumers.

Free market may encourage harmful goods

If there are people in the market who wish to buy dangerous goods like narcotic drugs, the
market will be ready to buy it since private firms will be willing to provide anything that is
profitable

Production may lead to negative externalities

When firms are always trying to maximize their profits, they may ignore external costs like
damages to the environment.

Free market economy may increase the gap between the rich and the poor

When firms and individuals are able to produce and consume freely, it may make the rich even
richer because they have more decision making power, and the poor may become poorer
because they have less decision making power in the market. The market system allocates
more goods and services to those consumers who have more money than others.

Cyclical fluctuations

Cyclical fluctuations are caused by the ever-changing demand and supply conditions.
Sometimes, when producers anticipate a rise in demand for certain goods, they raise
investment to produce more. But if demand actually does not rise, a general glut will occur, that
is, stock accumulation. Consequently, the affected producers will have to reduce investment,
dismiss workers toreduce costs. Both of these have an adverse effect in the economy as a
whole. Less investment meanslower production while lower employment means less
consumption, lower prices and profits. These cumulative effects lead to a lower national income.

Conclusion: It can be concluded that price mechanism determines allocation of resources as

per what consumers want more, which initially sounds right. However, this system cannot be left
to itself because of its various imperfections which undoubtedly necessitate government
intervention.

Centrally Planned or Command Economies

There are several different ways that an economic system distributes resources throughout a
society. When it is the government or state that makes these decisions instead of privately-
owned businesses and their customers, then we have what is called a centrally planned
economy.

What distinguishes a centrally planned economy from a market economy is that the production
and distribution responsibilities and resources are 100% controlled by the government or state.
The system insists on the following.

1. The government makes the economic decisions in addition to controlling all aspects of
production.
2. The state also decides how all resources are used or distributed.
 3. The government determines the final price for all goods and services.

The reason why most governments shy away from a system that is a complete centrally
planned economy is that the system does not take the will of the people or their needs into
account. It will always make decisions based on what is good for the government instead of
what the overall society requires.

Advantages

1. Prices are kept under control

Because supply and demand does not enter into the equation for a centrally planned economy,
the government can dictate what the prices should be for everyone in society. That makes it
much easier to set price levels to a place where the average consumer can afford to have the
items that they require.

2. Less economic inequality in this system.

In a centrally planned economy, the only people who tend to get “wealthy” from their
employment or actions are those who hold high-level government positions. Even then, the net
worth is tightly controlled for most parties in the system. Because the goal is to ensure that
everyone receives the same access to all of their needs, you will find that the inequality of
wealth in this system is considerably smaller than it is in free market systems.

3. You will not see a duplication of resource allocation in this economy.

The centrally planned economy wants to become as efficient as possible when producing and
distributing goods. Instead of spending resources on the same product made by three different
companies, there is one state-owned enterprise which is responsible for each item that is
necessary. This system seeks to use those resources elsewhere while offering one essential
choice each time.

4. There are lower levels of unemployment found in centrally planned economies.

Because the government is the one in charge of all of the businesses is a centrally planned
economy, then they are responsible for the overall unemployment rate. Jobs are readily
available in this system because the goal of the state is to ensure that everyone has work to do.
Although you may not receive a choice in what you get to pursue as a career, the government
does make an active effort to find positions that are representative of your skills, education, and
talent.

Disadvantages

1. There are high levels of inefficiency.

Because there is no motive for profit thanks to the price-setting schemes of the state in a
centrally planned economy, there is no reason for the companies that produce goods to become
more efficient in their processes.
.
2. You will still find a lot of waste in this system.
Although a centrally planned economy does work hard to eliminate financial waste and
duplication from their system, it does not do a good job of reducing the amount of productivity
waste that occurs. There is a lot of time that could be used more efficiently in this type of
economy because government officials must always stay in communication with each business
to ensure that all instructions are accurately followed.

3. Lack of consumer choice.

Consumers in this system can only choose the goods and services that the government
decides is appropriate for society. Anything that falls outside of that perspective could even be
illegal.

4. Restrict individual rights.

The goal of a centrally planned economy is to have everyone working toward a common goal
and vision that the government decides. People are not usually free to pursue their own
interests in this structure. If there is a shortage of farmers in a region, then that is what your
career will be until another decision is made about the employment options which benefit the
state.

5. No freedom of expression.
The government in a centrally planned economy has absolute rule over society. Anything can
be outlawed at a moment’s notice. If you step outside of this structure (even if your idea has
merit), then there is a chance that you could face house arrest, jail time, or worse.

Conclusion

It is a system which makes the assumption that the needs of the nation are not being met by
market forces. The state then takes over all areas of decision-making within the economy to
provide what it feels are the essential products and services that make life possible.

The pros and cons of a centrally planned economy show us that even though the government
makes the economic decisions, it may not be a positive choice. You have no choice in what
goods are produced, or how the production process will occur. There are more employment
options, but there are also fewer choices available for individual careers. It is a system which
promotes equality by providing the lowest-quality items to everyone while hoarding resources
for itself.

Problems of transition
Communist countries were known to have centrally planned economic system. However,
communism collapsed in the late 1980s. The countries of the former soviet union (known to
have had communism), after their independence, began to move away from central planning
towards market system, and thus became mixed economies. Economies which are in the
process of moving away from soviet-style central planning to market system are called
‘transition economies’.

Transition economies undergo a set of structural transformations intended to develop market-

based institutions. These include economic liberalization, where prices are set by market forces
rather than by a central planning organization. In addition to this trade barriers are removed,
there is a push to privatize state-owned enterprises and resources, state and collectively run
enterprises are restructured as businesses, and a financial sector is created to facilitate
macroeconomic stabilization and the movement of private capital.

However, the transition process has its own pains and problems.

Problems of transition when central planning in an economy is reduced

Rising unemployment

Transition process involves in privatisation of firms. The newly privatised firms face competition
from other firms, and thus try to be efficient. This also means that they will no longer employ
workers more than what is needed and the firms also may try to shift too capital-intensive
production methods. Transition also means that the government also will not employ as much
as before. This will create unemployment at least in the early stages of transition. Whether the
country will be able to solve will depend on its success in the transition process.

Rising inflation

Many transition economies also experienced price inflation as a result of the removal of price
controls imposed by governments. When this happened, the newly privatised firms began to
charge prices that reflected the true costs of production. In addition, some entrepreneurs
exploited their position and raised prices in an attempt to profit from the situation.

Inequality

Transition economies probably had a fairly equal distribution of wealth(atleast in the theory)
among the people. However, when the central planning is reduced, inequality tends to increase
as as some exploited their position as entrepreneurs and traders in commodities, while others
suffered from unemployment and rising inflation.

Corruption and consumer abuse

As the economy starts the transition, the legal system is usually not adequate to prevent
corruption. Loop-holes in the legal system would mean that the markets are not properly
regulated to protect consumers. Market-driven economies will only develop when citizens are
granted extensive property rights, and can protect these rights through the legal process. This
was largely absent in the former communist transition economies.

Mixed Economies
There is a third type of economy involving a combination of market forces and central
planning, called mixed economies.

Mixed economies may have a distinct private sector, where resources are allocated
primarily by market forces, such as the grocery sector of the UK economy. Mixed
economies may also have a distinct public sector, where resources are allocated mainly
by government, such as defence, police, and fire services.  In many sectors, resources
are allocated by a combination of markets and panning, such as healthcare and, which
have both public and private provision.

There are several advantages of mixed economy which are as below:

(i) Encouragement to Private Sector:

The most important advantage of mixed economy is that it provides encouragement to private
sector and it gets proper opportunity to grow. It leads to increase in capital formation within the
country.

(ii) Freedom:

In a mixed economy, there is both economic and occupational freedom as found in capitalist
system. Every individual has a liberty to choose any occupation of his choice. Similarly, every
producer can take decisions regarding production and consumption.

(iii) Optimum Use of Resources:

Under this system, both private and public sectors work for the efficient use of resources. Public
sector works for social benefit while private sector makes the optimum use of these resources
for maximisation of profit.

(iv) Advantages of Economic Planning:

In the mixed economy, there are all advantages of economic planning. Government takes
measures to control economic fluctuations and to meet other economic evils.

(v) Lesser Economic Inequalities:

Capitalism enhances economic inequalities but under mixed economy, inequalities can easily
controlled by the efforts of government.

(vi) Competition and Efficient Production:

Due to competition between both private and public sectors, the level of efficiency remains,
high. All factors of production work efficiently in the hope of profit.

(vii) Social Welfare:

Under this system, the main priority is given to social welfare through effective economic,
planning. The private sector is controlled by the government. Production and price policies of
private sector are determined to achieve maximum social welfare.

(viii) Economic Development:

Under this system, both government and private sector join their hands for the development of
socio-economic infrastructures, Moreover, government enacts many legislative measures to
safe guard the interests of the poor and weaker section of the society. Hence, for any
underdeveloped country, mixed economy is a right choice.

Demerits of Mixed Economy:

The main demerits of mixed economy are as follows:

(i) Un-stability:

Some economists claim that mixed economy is most unstable in nature. The public sector gets
maximum benefits whereas private sector remains controlled.

(ii) Ineffectiveness of Sectors:

Under this system, both the sectors are ineffective in nature. The private sector does not get full
freedom, hence it becomes ineffective. This leads to ineffectiveness among the public sector. In
true sense, both sectors are not only competitive but also complementary in nature.

(iii) Inefficient Planning:

There are no such comprehensive planning in mixed economy. As a result, a large sector of the
economy remains outside the control of the government.

(iv) Lack of Efficiency:

In this system, both sectors suffer due to lack of efficiency. In public sector it is so because
government employees do not perform their duty with responsibility, while in private sector,
efficiency goes down because government imposes too many restrictions in the form of control,
permits and licenses, etc.

(v) Delay in Economic Decisions:

In a mixed economy, there is always delay in making certain decisions, especially in case of
public sector. This type of delay always leads to a great hindrance in the path of smooth
functioning of the economy.

(vi) More Wastages:

Another problem of the mixed economic system is the wastages of resources. A part of funds
allocated to different projects in public sector goes into the pocket of intermediaries. Thus,
resources are misused.

(vii) Corruption and Black Marketing:

There is always corruption and black marketing in this system. Political parties and self-
interested people take undue advantages from public sector. Hence, this leads to emergence of
several evils like black money, bribe, tax evasion and other illegal activities. All these ultimately
bring red-tapism within the system.

(viii) Threat of Nationalisation:

Under mixed economy, there is a constant fear of nationalisation of private sector. For this
reason private sector does not put into use their resources for the common benefits.