Understanding How Opportunity Cost Relates to Scarcity

Scarcity is a reality of life. We never seem to have enough hours in the day or money in the bank to satisfy all our wants. In fact the whole science of economics revolves around the study of how people use scarce resources to satisfy unlimited wants. It is because we have to chose how to use these scarce resources that we face the idea of opportunity costs. If we use our resource for one purpose, by definition we sacrifice the next best alternative use of that same resource.

Economists often present this problem using the graph below. Here, a business is faced with a choice of how much of Product A or Product B to produce. Because resources are limited, it is not possible for the business to produce a combination of the two products at Point Y on this chart. In fact it is exactly because of the scarcity of resources that there is a limit to what can be achieved. It is possible for the business to produce varying quantities of both products in a certain combination. These different combinations are represented on the graph by the Production Possibility Frontier (PPF). The production Possibility Frontier is a graphical representation of the maximum amount of Product A the company can produce while simultaneously producing a certain amount of Product B. As more of Product B is produced, less of Product A is produced, and vice-versa.

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The hypothetical business presented in the graph can efficiently produce any combination of Product A and B at points A, B or C with the given amount of resources available. Producing at Point X is considered by economists to be inefficient. Why? Because it is possible to produce the same amount of Product A and produce more of Product B and vice-versa. In other words, the business does not need to produce less of one product to produce more of the other.

Scarcity also plays a role in our position on the PPF. As discussed earlier, a business is rarely able to produce more of Product B without sacrificing ever greater amounts of Product A. In other words, there is an opportunity cost to producing more of Product B in the way of producing less and less of Product A. Because resources are scarce, businesses face the fact that to produce more and more of Product B, they have to dedicate an ever increasing amount of less efficient resources to achieve the same output. If resources were not scarce, the PPF would be linear and the business would not face the opportunity cost of sacrificing more and more of Product A to increase production of Product B by a specific amount.