The basic economic problem: wants are unlimited but the resources to satisfy them are limited.

Define opportunity cost.

The value of the next best alternative given up when a choice is made.

Name the four factors of production and their rewards.

Land (rent), labour (wages), capital (interest) and entrepreneurship (profit).

Free good vs economic good?

A free good has no opportunity cost (e.g. air in normal conditions). An economic good uses scarce resources, so producing it has an opportunity cost.

Why is a typical PPC concave (bowed outward)?

Resources are not equally suited to producing both goods, so the opportunity cost of producing more of one good rises.

What does a point inside the PPC show?

Unemployed or inefficiently used resources. More of at least one good could be produced at no cost.

Economics

1.1 What is economics?

Economics studies how societies use limited resources to meet unlimited wants, which forces choices that always carry an opportunity cost. Study guide, 3 practice questions with markschemes and 9 flashcards. Free.

Economics as a social science · scarcity, choice and opportunity cost · factors of production · free goods vs economic goods · production possibilities curve · circular flow of income model · micro vs macro · the three basic economic questions and economic systems

Practise all 3 questions Study 9 flashcards

Study guide

The core problem: scarcity

Every society has more wants than it can satisfy, because the inputs it uses to make things are limited. This gap is scarcity, and it is the reason economics exists. Because resources are scarce, every use of them means giving up another use. The value of the best alternative given up is the opportunity cost of a choice. A town that spends its budget on a new stadium gives up, for example, the clinic it could have built instead.

Economics is a social science: it studies human behaviour, which is less predictable than physical systems, so economists rely on models and evidence rather than laboratory certainty.

Factors of production

Goods and services are made with four kinds of input, each earning its own reward:

Factor	Examples	Reward
Land	soil, minerals, forests, water	rent
Labour	human physical and mental effort	wages
Capital	machines, buildings, tools (man-made inputs)	interest
Entrepreneurship	organising the other factors and taking risk	profit

A free good has no opportunity cost (air in most places, sunlight). An economic good uses scarce resources, so producing it means sacrificing something else, even when it is handed out at zero price.

The production possibilities curve (PPC)

Diagram in words: the vertical axis shows the quantity of good A, the horizontal axis the quantity of good B. A curve bowed outwards (concave to the origin) joins the two axes and shows every maximum combination the economy can produce with all resources fully and efficiently used.

Points on the curve: full employment and productive efficiency.
A point inside the curve: unemployed or misused resources.
A point outside: unattainable with current resources and technology.
Moving along the curve shows opportunity cost: more of B means less of A.
The bowed shape shows increasing opportunity cost, because resources are not equally suited to both goods. A straight-line PPC would mean constant opportunity cost.
An outward shift (more resources, better technology, better education) is economic growth. If technology improves only in good B, the curve pivots outwards along the B axis while the A intercept stays put.

The circular flow of income

In the simplest model, households supply factors to firms and receive income; they spend that income on firms' output. Real flows (factors, goods) move one way and money flows move the other. Adding realism brings leakages (savings, taxes, import spending) that remove money from the flow and injections (investment, government spending, export revenue) that add it. If injections exceed leakages, national income rises; if leakages exceed injections, it falls.

Micro, macro and the three questions

Microeconomics studies individual markets, consumers and firms; macroeconomics studies the whole economy (growth, inflation, unemployment). Every society must decide what to produce, how to produce it and for whom. A free market economy answers through prices and private ownership; a planned economy through government direction; real economies are mixed, with different balances of market and state.

Common mistakes

Defining opportunity cost as "the cost of something" instead of the next best alternative forgone.
Calling capital "money". In economics capital means man-made physical inputs.
Drawing a PPC shift for a fall in unemployment. Unemployment is a point inside; reducing it moves the point towards the curve.
Treating a good given away free (a public park) as a free good. It still has an opportunity cost.

Exam tips

10-mark questions: define scarcity and opportunity cost, draw a fully labelled PPC, and walk through what each point or shift means. Link every diagram to the question's context.
15-mark questions: evaluate, for instance, whether a country should shift resources towards capital goods. Weigh short-run sacrifice in consumer goods against faster long-run growth; consider who bears the cost and over what time frame.
In data questions, opportunity cost from a PPC table equals the units of one good lost divided by the units of the other gained.

Cheat sheet

Opportunity cost (PPC) = units of A given up ÷ units of B gained
PPC checklist: two goods on axes, concave curve, points inside / on / outside, arrow for shift
Inside = unemployment or inefficiency · On = efficient · Outside = unattainable now
Concave shape = increasing opportunity cost; straight line = constant
Outward shift: more or better resources, technology. Pivot: tech change in one good only
Leakages: S, T, M · Injections: I, G, X
Injections > leakages → income rises; leakages > injections → income falls
Factor rewards: land → rent, labour → wages, capital → interest, enterprise → profit
Three questions: what, how, for whom · Systems: market, planned, mixed

Key definitions

Scarcity: The situation in which limited resources cannot satisfy all human wants, so choices must be made.
Opportunity cost: The value of the next best alternative given up when a choice is made.
Factors of production: The inputs used to make goods and services: land, labour, capital and entrepreneurship.
Free good: A good whose production or use involves no sacrifice of scarce resources, so its opportunity cost is zero.
Economic good: A good that requires scarce resources to produce and therefore has an opportunity cost.
Production possibilities curve: A curve showing the maximum combinations of two goods an economy can produce when all its resources are fully and efficiently used.
Circular flow of income: A model showing how income, spending and factor services flow between households, firms, government and the rest of the world.
Mixed economy: An economy in which both markets and the government play significant roles in allocating resources.

Practice questions

SLPaper 1Challenging

Question 1

(a) [10]

Using a production possibilities curve (PPC) diagram, explain how a technological breakthrough in only one industry could affect an economy's production possibilities.

Markscheme

1 Defines the key economic terms used in the question accurately
2 Accurate PPC diagram: axes labelled with the two goods, concave curve, and an outward pivot along the axis of the industry with the new technology only
2 Explains that the maximum output of the improved good rises while the maximum of the other good is unchanged
2 Explains that the economy can now reach combinations that were previously unattainable, so more of both goods is possible
2 Explains that the opportunity cost of the improved good (measured in units of the other good) falls
1 Uses a relevant real-world or hypothetical example, e.g. automated harvesting in agriculture

(b) [15]

Evaluate the view that a low-income country should devote a greater share of its resources to capital goods rather than consumer goods.

Markscheme

1 Defines capital goods and consumer goods
2 Accurate PPC diagram(s) showing a point closer to the capital-goods axis today and a larger outward shift of the PPC in the future
3 Explains that more capital goods today raise productive capacity and future living standards (long-term growth)
2 Uses a relevant real-world example of a country prioritising investment
2 Evaluates: the opportunity cost is lower consumption now, which may be hard to accept where incomes are near subsistence
2 Evaluates: capital is only productive with complementary inputs (skilled labour, infrastructure, institutions)
2 Evaluates: considers short run vs long run trade-off and who bears the cost, reaching a supported conclusion
1 Overall balanced judgement that weighs the arguments rather than listing them

SLPaper 2Standard

Question 2

The table shows the maximum combinations of output for the invented country of Valdoria.

Point	Solar panels (thousand units)	Wheat (thousand tonnes)
A	0	500
B	100	450
C	200	380
D	300	280
E	400	150
F	500	0

(a) [2]

Define the term opportunity cost.

Markscheme

1 The value of the next best alternative
1 that is given up when a choice is made

(b) [2]

Calculate the opportunity cost of increasing solar panel output from 200 to 300 (thousand units).

Markscheme

1 Wheat falls from 380 to 280 thousand tonnes
1 Opportunity cost = 100 thousand tonnes of wheat (1 tonne of wheat per panel)

(c) [4]

Using the data, explain why Valdoria's PPC is bowed outwards (concave to the origin).

Markscheme

1 Calculates successive opportunity costs of each extra 100 thousand panels: 50, 70, 100, 130, 150 thousand tonnes of wheat
1 Identifies that the opportunity cost rises as more panels are produced
2 Explains that resources are not equally suited to both goods, so ever less suitable land and labour must be moved out of wheat

(d) [2]

In 2025 Valdoria produced 180 thousand panels and 300 thousand tonnes of wheat. State what this suggests about the use of its resources.

Markscheme

1 This point lies inside the PPC (at 180 panels more than 380 thousand tonnes of wheat is attainable)
1 so resources are unemployed or used inefficiently

SLPaper 1Standard

Question 3

(a) [10]

Using the circular flow of income model, explain how changes in leakages and injections affect the level of economic activity.

Markscheme

1 Defines the key economic terms used in the question accurately
2 Accurate circular flow diagram showing households, firms, government, the financial sector and the foreign sector with real and money flows
2 Identifies the leakages (saving, taxes, import spending) and injections (investment, government spending, export revenue)
2 Explains that when injections exceed leakages the flow of income grows, raising output and employment
2 Explains that when leakages exceed injections the flow of income shrinks
1 Uses an example, e.g. a rise in household saving during uncertainty reducing spending on firms' output

Key facts

What is scarcity?: The basic economic problem: wants are unlimited but the resources to satisfy them are limited.
Define opportunity cost.: The value of the next best alternative given up when a choice is made.
Name the four factors of production and their rewards.: Land (rent), labour (wages), capital (interest) and entrepreneurship (profit).
Free good vs economic good?: A free good has no opportunity cost (e.g. air in normal conditions). An economic good uses scarce resources, so producing it has an opportunity cost.
Why is a typical PPC concave (bowed outward)?: Resources are not equally suited to producing both goods, so the opportunity cost of producing more of one good rises.
What does a point inside the PPC show?: Unemployed or inefficiently used resources. More of at least one good could be produced at no cost.