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Scarce Resources and Opportunity Cost

Classical economics is based on the idea that individuals and societies need certain important resources in order to thrive. Inevitably those important resources are scarce – there are not enough of them to meet everyone’s needs or wants. Much of economics is based on the question of how we go about allocating those scarce resources.

Let’s use an example that most of us will recognize. Let’s consider that time is a scarce resource. We value time, we always would like more of it, and we often don’t have enough of it. We have to decide how to allocate our scarce supply of time among various activities – including studying, sleeping, working, eating, and recreation. So time is the scarce resource, and we make various decisions on how to allocate time among competing uses.

So, what’s another scarce resource for most of us? How about money? With some pretty rare exceptions we don’t have enough of it – so it is scarce. Every day we make decisions about how to use, or allocate, the little bit of money that we have.

Now, let’s broaden our perspective just slightly. Imagine you are living in a household – perhaps with a family, or a roommate, or a significant other. Your household needs more money and more time than are available, and you have the same allocation decisions to make about them. In addition, your household has only a certain amount of basic, unskilled labor. You might ask, “what does labor have to do with my home or apartment?” Well, ask that question the next time you argue about who gets to take out the trash, wash the dishes, or do the laundry. Each of those activities require fairly unskilled labor, and households with more people can divide up those tasks more easily than someone living alone. So, we have added labor to our list of scarce resources. We define labor as kind of raw, unskilled warm bodies.

What if you or someone in your household is good at fixing cars? Or perhaps one or more of you have enough experience to be hired out as a food waiter? In each case, the concept of unskilled labor is being embellished, based on some skills, knowledge, or experience you might have. Can you see how a household which holds more of those skills or knowledge has a greater store of this important scarce resource?

When we were thinking about time as a scarce resource, we understood that there are a number of different ways to use time. Let’s pick two – studying for class or having fun. Let’s say it is Thursday evening, the weekend is less than a day away and you have to decide whether to study for economics or go see a movie.

If you decide to stay home and study there are some benefits that come from that decision – hopefully a better grade. And yet, if you decide to study it means you are giving up a fun evening at the movies with friends. Your decision to study brings with it a cost – that you have to give up something you would have enjoyed. We call this opportunity cost.

Opportunity cost is a crucial concept in economics and it guides much of the decisions we make. Robert Frost wrote about choices:

Two roads diverged in a yellow wood,
And sorry I could not travel both

Whatever path we take, and the benefits that come from that choice, there is always a cost in terms of the benefits we will not get to enjoy from going the other way.

Take a second right now to think of some decision you typically make. Perhaps it is what to do this evening. Or maybe you need to decide how to spend the $10 left in your pocket. Whatever the decision think about your choice, and then consider what you are giving up by making that choice. That “what you are giving up” is the opportunity cost.

One more example of opportunity cost that most of us can only dream about… Imagine that you are a superb athlete, musician, or artist. You are given the choice to continue going to school, or leaving school to turn “pro.” What is your opportunity cost if you decide to stay in school and put off your professional dreams for another year or two? In this case your “cost” of going to school another year is the money, fame, or whatever that you give up in order to stay with your studies.

Now turn the decision around. If you decide to “turn pro” what is your opportunity cost? It is the benefit you would have gotten from another year of a college education.

OK, earlier we listed some examples of scarce resources, as seen from the perspective of an individual or a household. Now let’s ask the same questions about a country, or a state.

One resource that is scarce for a country is capital. We can loosely think of this as “big money.” Now obviously a country can print as much currency as it wants. The real, scarce financial resource is capital – loaned by investors or gained through the sale and export of goods. Countries have to make some critical decisions on how to use scarce capital. Should they build roads, develop communication, build schools, or invest in developing ports? All of these require capital and there is never enough of it.

Traditionally land has been listed as a scarce resource, and that still applies today. Countries with more land have more opportunities for growth, or agriculture, or mining.

Natural resources are another key scarce resource for a country. Abundant water, healthy forests, precious minerals, and arable land all can contribute to a country’s success. Yet we often seem to not have enough of them.

And, similar to our household, labor is a key scarce resource. We still think of labor as warm bodies – no skills, just people to do simple work.

We can provide leverage for that labor, if we have more skills, knowledge, or experience. These skills are often in short supply, so they qualify as a scarce resource. Gaining more of these resources make our labor much more productive.

Let’s review the list again:
For individuals and households we have these scarce resources:

  1. Time
  2. Money
  3. Labor
  4. Skills/Knowledge

For countries we have:

  1. Capital
  2. Land
  3. Natural Resources
  4. Labor
  5. Skills/knowledge

And one final thing to review – opportunity cost. Remember to think of opportunity cost in the context of a decision or a choice. Whichever choice you make you turn your back on the benefits of the choice not made – the road not taken.

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