Foundations of Economics — Scarcity, Opportunity Cost & Economic Systems

What Is Economics?

Economics: the study of how individuals, firms, and societies allocate scarce resources.

The Three Fundamental Questions

1. What goods and services should be produced, and in what quantities? (What)
2. How should they be produced? (How)
3. Who receives the output? (For Whom)

• Microeconomics: decisions of individuals, households, firms, and markets
• Macroeconomics: national output, price level, unemployment, interest rates, and exchange rates (the domain of the Fed, BLS, and BEA)

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Scarcity and Choice

Scarcity

• Human wants are unlimited; resources are finite
• The root cause of every economic problem

The Necessity of Choice

• Scarcity forces trade-offs
• Every choice means giving something up

Cost Concepts

• Explicit cost: actual cash outlay
• Implicit cost: value of the best forgone alternative
• Economic cost = explicit + implicit cost

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Opportunity Cost and Sunk Cost

Opportunity Cost

Opportunity Cost: the value of the single best alternative you give up when making a choice

Example

• Going to college vs. working full-time → Opportunity cost of college = forgone after-tax salary + tuition paid

Key Rule

• Opportunity cost = the ONE best forgone option (not the sum of all forgone options)

Sunk Cost

Sunk Cost: a cost already incurred and unrecoverable — irrelevant to future decisions

Sunk-Cost Fallacy

• “We’ve already spent $30,000 on this project, so we can’t quit now.” → The $30,000 is sunk → consider only future benefits vs. future costs

Rational Decision Rule

• Continue if marginal benefit > marginal cost
• Stop if marginal benefit < marginal cost

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Production Possibilities Frontier (PPF)

PPF: the maximum combinations of two goods an economy can produce given its resources and technology

• Points on the curve: productively efficient
• Points inside: inefficient (idle resources)
• Points outside: currently unattainable (reachable through growth or technology)
• Slope of PPF = opportunity cost
• Bowed-out (concave) PPF: Law of increasing opportunity cost → As more of Good X is produced, ever-larger amounts of Good Y must be sacrificed

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Economic Systems

Market Economy (Capitalism)

• Resource allocation via the price mechanism
• Private property and profit motive
• Strengths: efficiency, innovation
• Weaknesses: inequality, market failures

Planned Economy (Command)

• Government directs resource allocation
• Strengths: equity, public-good provision
• Weaknesses: inefficiency, weak incentives

Mixed Economy (Reality)

• Market foundation + government intervention
• All modern economies — US, EU, Japan — are mixed
• The US: market-dominant with social safety net, antitrust enforcement, and regulatory agencies (FTC, EPA, FDA, SEC)

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Key Concept Cards

Opportunity Cost = Best Forgone Alternative ★★★★★ : Among all the options you give up, only the single best one counts as the opportunity cost. Includes both explicit and implicit costs. Memory hook: opportunity cost = the ONE best thing you didn’t choose

Ignore Sunk Costs ★★★★★ : Once spent and unrecoverable, a sunk cost is irrelevant. Compare only marginal benefit vs. marginal cost going forward. Memory hook: sunk cost = ancient history — don’t let it trap you

PPF Slope = Opportunity Cost ★★★★☆ : A bowed-out PPF reflects increasing opportunity cost. Producing more of X requires sacrificing increasing amounts of Y. Memory hook: concave PPF = rising opportunity cost

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Practice Questions

Q. A startup has spent $30,000 and incurred $5,000 in losses so far. Investing an additional $2,000 is projected to generate $4,000 in revenue. Should the company continue?

Yes. Ignore the sunk costs ($35,000 total spent). The relevant comparison: additional cost $2,000 vs. additional revenue $4,000 → net gain +$2,000. Marginal benefit ($4,000) > marginal cost ($2,000) → continue.

Q. Which of the following is included in opportunity cost? ① Textbook purchase ② Forgone part-time wages ③ Last semester’s tuition

① and ②. ③ is a sunk cost (already paid, unrecoverable). ① is an explicit cost; ② is an implicit cost — both are part of the true economic opportunity cost of the decision.