Scarcity, Choice and Opportunity Cost: Economics 9708 (Cambridge International AS & A Level)

Scarcity forces every economy to combine four types of resource, known as the factors of production, in order to produce goods and services. A friend tells you: "My aunt is putting $120,000 of capital into her new furniture workshop."

An economist listening to this would point out that, precisely speaking, only part of what is being described here counts as capital in the economic sense of the word.

Which of the following is the factor of production that economists define as capital?

A family farm has 100 hectares of land, all currently planted with maize, which generates revenue of $400 per hectare per year. A local agribusiness has offered a guaranteed contract to buy sugarcane at a price that would generate revenue of $550 per hectare per year.

Converting a hectare of land from maize to sugarcane requires irrigation work that must be paid for as a one-off cost in the first year only. Because the plots nearest the farm's existing water source can be converted most cheaply, this one-off conversion cost rises for each additional hectare converted, as shown in Table 1. In deciding how much land, if any, to reallocate, the family is answering the basic economic question of what to produce, one hectare at a time. That is, at the margin.

Table 1: cost and revenue of converting land from maize to sugarcane

(a) Using Table 1, calculate the net benefit, in the first year, of converting the 1st hectare of land from maize to sugarcane. Show your working. [2]

(b) Using Table 1, determine, at the margin, the total number of hectares the family should convert from maize to sugarcane in the first year in order to maximise its net benefit. Show your working for every hectare in the table. [4]

(c) Explain why the opportunity cost of maize forgone remains constant at $400 per hectare for every hectare converted, whereas the one-off conversion cost rises for each additional hectare converted. [2]

A household signs a fixed 12-month electricity tariff contract with SupplyCo. For the remaining months of the contract, the household cannot switch to a different supplier without paying a $150 early-exit fee, but once the 12 months are up it is completely free to switch supplier or change how much electricity it uses.

(a) Define what economists mean by the short run and the long run when these ideas are applied to a consumer's spending commitments, rather than to a firm's factors of production. [2]

(b) Two months into the contract, with 10 months remaining, a rival supplier, PowerDirect, offers a cheaper tariff that would save the household $8 per month for as long as it stays with PowerDirect. Calculate the net financial outcome, over the 10 remaining months, of paying the $150 exit fee now to switch immediately to PowerDirect, and use your answer to explain the opportunity cost of switching now rather than waiting until the SupplyCo contract ends. [4]

(c) Discuss the extent to which a consumer's opportunity cost of moving to a cheaper alternative is lower in the long run than in the short run. [3]

A government economic adviser makes four statements while presenting a proposal to raise the national minimum wage to $12 per hour.

Statement 1: "Raising the minimum wage to $12 per hour would increase the earnings of the lowest-paid 15% of workers, ceteris paribus."

Statement 2: "The government should raise the minimum wage to $12 per hour, because it is unfair that any full-time worker earns below the poverty line."

Statement 3: "A rise in the minimum wage to $12 per hour would, other things being equal, raise employers' wage costs for their lowest-paid staff by 18%."

Statement 4: "It would be wrong for the government to prioritise higher wages over the risk of job losses among low-skilled workers."

(a) Identify which TWO of the four statements are normative statements. For each one, give a reason for your choice. [4]

(b) Using either Statement 1 or Statement 3 to illustrate your answer, explain what economists mean by the "ceteris paribus" assumption. [3]

(c) Explain ONE reason why the ceteris paribus assumption behind Statement 1 might not hold in reality once the minimum wage is actually raised. [2]

(d) Enforcing the new minimum wage is expected to cost the government's labour inspectorate an extra $3 million a year, which must come out of the inspectorate's fixed annual budget. State the economic concept that describes what the inspectorate gives up by spending this $3 million on minimum-wage enforcement, and give one example of an alternative use of these funds. [2]

Economists distinguish an economic good, which requires scarce resources to produce and therefore has a positive opportunity cost, from a free good, which can be enjoyed without giving up any alternative use of a scarce resource.

Which of the following is correctly classified as a free good rather than an economic good?

A hospital has only a limited number of intensive care unit (ICU) beds available on any given day. When the number of patients needing critical care exceeds the number of free beds, doctors must use medical triage criteria, such as how likely each patient is to survive with treatment and how urgently they need it, to decide which patients are treated first.

Economists describe every economy, and every institution within it, as having to answer three basic questions because of scarcity, what to produce, how to produce it, and for whom to produce it.

Which basic economic question is being answered by the hospital's decision about which specific patients receive its scarce ICU beds today?

Amara is a freelance photographer. Next Saturday she has exactly one full day free, and she has received two mutually exclusive job offers for that day, so she can accept only one of them.

Job 1 is a wedding shoot. It would bring in revenue of $500, but Amara would need to pay a second photographer to assist her and buy extra printed photo albums, costing $80 in total.

Job 2 is a set of corporate headshots for a local company. It would bring in revenue of $350, with only $30 of costs for props and travel.

(a) Calculate the profit Amara would earn from Job 1 and the profit she would earn from Job 2. Show your working for each. [2]

(b) State which job Amara should accept if her only goal is to maximise her profit from Saturday's work, and calculate the opportunity cost, in dollars, of accepting that job. [3]

(c) Amara mentions that the corporate client in Job 2 often has repeat photography work throughout the year, whereas the wedding in Job 1 is a one-off booking. Explain why this means the true opportunity cost of accepting Job 1 might be larger than the dollar figure calculated in part (b). [2]

A regional rail operator's economist makes the following statement while proposing a change to ticket prices:

"A 10% cut in the price of off-peak rail season tickets would increase the number of passengers who buy them, ceteris paribus."

(a) Explain why this is a positive statement rather than a normative statement. [2]

(b) State what the ceteris paribus assumption means in this context, and identify ONE specific factor, other than the price of the season ticket itself, that the statement is assuming stays unchanged. [3]

(c) Discuss the extent to which the ceteris paribus assumption is likely to make this statement an unreliable guide to what actually happens to passenger numbers in the real world. [4]

Three different decision-makers each face scarcity, because the resource they have available cannot satisfy every use they might want to put it to.

Scenario 1: A student has exactly one free afternoon before her exam. She can use it either to revise for the exam, or to work a paid shift at a supermarket.

Scenario 2: A small bakery owns exactly one delivery van. On Friday morning, two different restaurants each place a bread order that needs delivering at the same time, so the van can deliver to only one of the two restaurants that morning.

Scenario 3: A town council owns exactly one unused plot of public land. It can use the plot to build either a new library or a new sports centre, but building one of these uses up the plot so that the other cannot also be built there.

(a) For each of the three scenarios, identify the opportunity cost of choosing the first option named (revising for the exam; delivering to the first restaurant's order; building the library). [3]

(b) Using Scenario 2, explain why the bakery's inability to deliver both orders on time is a direct consequence of scarcity. [2]

(c) Explain how Scenario 3 shows that scarcity forces choices on a government, and not only on individuals, such as the student in Scenario 1, or firms, such as the bakery in Scenario 2. [2]

A government is considering introducing a carbon tax on domestic flights. Four commentators each make a claim about this proposed tax.

Claim 1: A $50-per-tonne carbon tax would raise the price of an average return domestic flight by around $12, ceteris paribus.

Claim 2: A carbon tax is essential if the country is to meet its environmental responsibilities.

Claim 3: Introducing a carbon tax would reduce the quantity of domestic flights demanded, ceteris paribus.

Claim 4: Government data show that domestic flight numbers fell by 12% in the year after a similar carbon tax was introduced in a neighbouring country.

Which ONE of these four claims is a normative statement?