IGCSE Economics 0455: The Basic Economic Problem in a Small Firm

Oakmere Furniture is a small workshop with one workshop building, a fixed team of five carpenters, and a limited delivery of timber each month. Even though the workshop works at full capacity every month, its customers place far more orders for tables, chairs and cabinets than Oakmere Furniture can ever produce with these resources.

This month, Oakmere Furniture must decide how to use its limited timber. It chooses to use all of this month's timber to make cabinets rather than tables.

(a) Using the passage, explain what economists mean by "the basic economic problem". [2]

(b) State the three basic economic questions that this problem forces a producer such as Oakmere Furniture to answer, and give one example from the passage of how Oakmere Furniture is currently facing one of these questions this month. [4]

(c) Explain the opportunity cost to Oakmere Furniture of using this month's timber to make cabinets rather than tables. [2]

Part (a): The basic economic problem

Oakmere Furniture’s resources are strictly limited: one workshop building, five carpenters and only a fixed delivery of timber each month. These finite resources mean the workshop can only ever produce a certain amount of furniture in a month, however efficiently it works.

At the same time, customer demand for tables, chairs and cabinets keeps outstripping what the workshop can supply, even when it is already working at full capacity. In economics, this is treated as an example of wants being, in effect, unlimited. There is always more that customers would like to buy than the workshop’s resources allow it to make.

The basic economic problem is exactly this mismatch: resources are finite, but wants for what those resources could produce are unlimited. Because of this mismatch, Oakmere Furniture cannot simply produce “enough” of everything; it must constantly choose which goods to make with the limited timber, carpenters and workshop space it has.

Part (b): The three basic economic questions

Because resources are scarce relative to wants, every producer, including Oakmere Furniture, is forced to answer three basic questions:

What to produce. For example, whether this month’s timber should become tables, chairs or cabinets.
How to produce it, for example, how to combine the five carpenters, the workshop space and the timber to make the chosen goods.
For whom to produce it. For example, which customers’ orders get priority when there is not enough output to satisfy every order placed.

Oakmere Furniture is currently facing the first of these questions directly: by choosing to use all of this month’s timber to make cabinets rather than tables, it is answering the “what to produce” question in favour of cabinets.

Part (c): The opportunity cost of the timber decision

Oakmere Furniture’s timber this month is a fixed, limited resource: once it has been used to make cabinets, it is no longer available to make tables. By choosing to use all of this month’s timber for cabinets, the workshop gives up the tables it could otherwise have made with that same timber and the same carpenters’ time.

This forgone output, the tables that are not made this month because the timber went into cabinets instead, is the opportunity cost of the decision. It is not the cabinets themselves (that is the benefit of the choice actually made), but the next best alternative use of the same scarce resources that had to be sacrificed.

Final answers

(a) The basic economic problem is the mismatch between Oakmere Furniture’s finite resources (workshop, carpenters, timber) and the unlimited wants of its customers, which forces the workshop to choose which goods to produce.
(b) The three basic economic questions are: what to produce, how to produce it, and for whom to produce it. This month, Oakmere Furniture answers “what to produce” by choosing cabinets over tables.
(c) The opportunity cost is the tables that Oakmere Furniture gives up making this month, because the same timber and workshop time have been used to make cabinets instead.