Scarcity and opportunity cost

Alphonso has $10 a week. Burgers cost $2 and bus tickets 50 cents, so one more burger costs him four bus tickets.

Wanting more than there is

Economics starts from a plain observation. OpenStax puts it this way: scarcity means that human wants for goods, services and resources exceed what is available. Workers, land, machines and raw materials are limited, and so is time. Everyone, rich or poor, has the same 24 hours in a day. Economics is the study of how people make decisions when they cannot have everything, whether the decision is made by one person, a family, a business or a whole country.

Scarcity is not the same thing as poverty. A rich country still has to choose between spending on roads or on schools, and a busy person with plenty of money still has to choose between an evening at the gym and an evening with friends. Whenever a resource has more than one use, using it one way means not using it another way.

The budget line

Alphonso's weekly problem is small enough to draw. He has $10 to split between burgers at $2 and bus tickets at 50 cents. If he spends everything on burgers he gets $10 ÷ $2 = 5 burgers and no bus rides. If he spends everything on tickets he gets $10 ÷ $0.50 = 20 tickets and no lunch. The straight line between those two corners is his budget constraint, or budget line. Every point on it costs exactly $10; points inside it leave money unspent; points outside it cost more than he has.

In the model the green triangle is everything he can afford. Put the slider on 12 tickets. The tickets cost 12 × $0.50 = $6, the remaining $4 buys 2 burgers, and the dot sits exactly on the line. That is point D in the OpenStax table.

Opportunity cost

What does one more burger cost Alphonso? The quick answer is $2, but economists ask a different question: what does he have to give up? To stay inside $10, an extra burger means four fewer bus tickets, because $2 ÷ $0.50 = 4. Economists call this the opportunity cost: the value of the next best alternative you give up. The slope of the budget line shows it. Moving one ticket to the right costs a quarter of a burger, which is why the slope is −0.25.

Opportunity cost is often larger than the money you pay. OpenStax gives a lunch example: buying an $8 lunch instead of bringing a $3 lunch from home costs $5 a day, and over 250 working days that is $1,250, perhaps the price of a holiday. Time counts too. Going to college costs tuition and books, and it also costs the wages you could have earned in those hours.

Sunk costs and thinking at the margin

Two more ideas help with real choices. First, most decisions are about a little more or a little less, not all or nothing. Alphonso is unlikely to buy 20 tickets and no food. Economists call this marginal thinking: compare the extra benefit of one more unit with its extra cost. Second, money that is already spent and cannot be recovered, a sunk cost, should not drive the next decision. If a film is terrible after 30 minutes, the $8 ticket is gone either way. The real question is whether the next 90 minutes are better spent in the cinema or somewhere else.

Markets are one of the ways a society handles scarcity. Prices tell people how scarce something is, and the rest of this course shows how buyers and sellers together set those prices.