Opportunity Cost & the Free Market

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Opportunity Cost And The Free Market

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Category: Business

Autor: anton 06 July 2011

Words: 1760 | Pages: 8

OPPORTUNITY COST & THE FREE MARKET

Scarcity is one of the most basic and crucial points to understand in microeconomics.1Scarcity means that we cannot have all the needs and wants to satisfy our desires. Scarcity can be applied to almost anything. Due to the scarcity of products we must make a choice of what we want. We must choose whether to do one thing or another by what we value to be most important to us. This, therefore, leads to us opportunity cost. Usually when one has to make a decision over what to do, buy, or build, it is narrowed down to two things. We might choose what satisfies our desires, what is more economical, or what is needed more. The choice that we do not take is our opportunity cost, the choice that we value less. Scarcity, choice, and opportunity cost are all related and interlaced with one another. If resources were unlimited we would never have to choose what is more important to have because we would have it all. A good example of applying scarcity would be with time. Have you ever had to decide whether to stay home and study or go out and party? By choosing to go out and party we take time away from our studying. This is a choice that we have to make and whatever we decide not to do is our opportunity cost.

Since resources in our economy are limited we must decide what is more important and where to apply our money and time. A production possibility curve shows us opportunity cost and how to get the best possible combination of our two choices. The production possibility curve might help us to better understand how to bring things to equilibrium and therefore not have to sacrifice a choice but to combine them. The production possibility curve is illustrated in a diagram; through the diagram we see the best possible combination to allocate resources. For example, if a government has enough resources to build schools and libraries it should then come to equilibrium and do the maximum possibility of both. As shown on the diagram below if the government only builds schools then they are at point A, which means they are not building libraries, therefore not allocating resources. If they concentrate only on building libraries, and not schools, then they are at point E. In order to build both they would need to place themselves at points B, C, and D. At point B there is a bigger production of schools and a small production of libraries. At point D, there is a larger production of libraries and a smaller production of schools. The most effective point would be C because they would concentrate all their efforts on both schools and libraries and therefore have the best allocation of resources and have no opportunity cost.

All these factors combined are essential to making better economical decisions for any society. The production possibility curve helps deicide more efficient ways to distribute resources. Businesses and government have to find all the different possibilities, study them, and make the best decision on what is best to produce and what would bring in more profit. Opportunity cost can also help us understand what products a consumer might choose to buy and the best price for the product. This can also help companies decide on better ways to proceed with sales.

The free market is a well-advanced state of economy in a society. Through this market we have free enterprise, choice of specialization in labor, circular flow of income, capital, and private property. In this market there in no government intervention of any kind, it is based on the theory of “every man for himself”. This system leads to innovations and creativity because it is open for all who want to partake in it.

Lets examine in more detail the benefits this market has to society. First lets take a look at free enterprise. Free enterprise means that individuals are free to attain any resources they wish, arrange them in any way they want, and then resell them to the public without any restrictions or interventions from the government. The public, at free choice, subsequently buys this product; the fact that this product is bought by the public favors it over others and in many ways determines what is produced. 2

Next, we have the choice to specialize in any kind of labor that we wish. This is paid through income, which in return motivates people to work more and be competitive. Adam Smith, a Scottish economist, was in favor of this economy; he believed that the people were wielded by an “invisible hand” that produced the wealth of nations in the best of all possible ways. 3

Free enterprise and freedom to specialize in labor leads to a circular flow of income. This happens when individuals sell labor to businesses and are paid in the form of wages, interest, rents, and profits. These individuals then buy products from the businesses, which in return receives money for their sales.4

All of the above mentioned lead