Scarcity is the root cause of all economic problems. We know that resources are scarce or short in supply in relation to demand; but wants or ends are unlimited. As a consequence, we face the problem of choice among so many of our wants. This is because scarce means have alternative uses. Thus, we have to choose among the most urgent and less urgent wants. In fact, the basic problem of an economy is the problem of choice. More precisely, problem before us is to take right decisions in regard to the goals or ends to be attained and the way, the scarce means to be utilized for this purpose. Every economy faces some fundamental problems called as central problems of an economy. These are the following:

(1)     What goods and services are to be produced? The first major problem faced by an economy is what types of goods and services to be produced. As resources are limited, we must choose between different alternative collection of goods and services that may be produced. It may also imply whether to produce capital/producer goods or consumer goods. Moreover, we have to decide about the quantity of the goods to be produced in the economy.

(2)     How to produce these goods and services? The next problem we have to tackle is the problem of how to produce the desired goods in the economy. Thus the question of techniques to be used in the production comes in the mind. Whether we should use labour-intensive technique or capital – intensive technique. Labour-intensive method of production implies more use of labour per unit than capital whereas; capital-intensive technique indicates more use of capital per unit than labour. The choice depends on the availability of resources. A labour surplus economy can well use the labour–intensive technology.

(3)     For whom these goods and services are to be produced? Once we have decided what goods to be produced and what techniques to be used in the production of goods, we are encountered with another problem, i.e., the problem of distribution of goods in the economy. This is the problem of sharing of national income.

(4)     Are the resources efficiently used? We have also to see that scarce resources are efficiently utilized. This is the problem of economic efficiency or welfare maximization.

(5)     Are the resources fully employed? An economy must also try to achieve full employment of all its resources.

(6)     How to attain growth in the economy? An economy is to ensure that it is attaining sufficient growth rate so that it is able to grow larger and larger and develop at faster rate. It should be able not only to make a structural change from agrarian to industrial sector but also to increase per capita and national income of the country. An economy must not remain static. Its productive capacity must increase continuously.

It is clear that the basic problem of an economy is the economizing of resources. The economizing problem arises in every type of economic society owing to the fact that resources are scarce in relation to multiple wants/ends.


The production possibility Curve is a graph that depicts the trade-off between any two items produced. It is also known as Transformation Curve or Production Frontier, which shows the maximum feasible quantities of two or more goods that, can be produced with the resources available. In other words, it indicates the opportunity cost of increasing one item’s production in terms of the units of the other forgone. Prof. Samuelson analyzed the economizing problem by the use of production possibility curve.

Thus, a PPC shows the maximum obtainable amount of one commodity for any given amount of another commodity, given the availability of factors of production and the society’s technology and management skills. The concept is used in macroeconomics to show the production possibilities available to a nation or economy, and also in microeconomics to show the options open to an individual firm. All points on a production possibilities curve are points of maximum productive efficiency or minimum productive inefficiency: resources are allocated such that it is impossible to increase the output of one commodity without reducing the output of the other. That is, there must be a sacrifice—an opportunity cost—for increasing the production of any good. All resources are used as completely as possible (without the situation becoming unsustainable) and appropriately. The production possibility curve does not remain stationary. It moves outward overtime with growth of resources and improvement in technology. This is because we get more output from the same quantities of resources. The table below illustrates production possibilities of a simple economy producing two commodities—cars and computers. Two production possibilities–E and F are shown. When the economy decides to put more resources for the production of computers, it must sacrifice some resources from the production of cars. Thus, when 10000 computers are decided to be produced, 5000 cars cannot be produced as the resources are now diverted to the production of computers.

Computers (in
Cars (in


The below diagram derived from the table above, shows the production possibility curve. If all resources in the economy are utilized in the production of cars, OA units of cars can be produced.

On the other hand, if all resources are put in the production of computers, OB units of computers would be produced in the economy. Joining points A and B, we get production possibility curve AB. In case, the economy decides to produce both the commodities by using the available resources, it can produce various combinations of cars and computers by staying on the curve AB, such as at E or F. At point E, it can produce OS units of cars and OT units of computers. Similarly, at F, ON units of cars and OM units of computers can be produced. Thus, the points E, F or any other point on curve AB show maximum feasible combinations of cars and computers which can be produced with the resources available. Point C in the figure is not attainable or feasible for the economy as it is above the production possibility curve AB, i.e., beyond the capacity of the economy. Again, it will not produce at point D which is though attainable but not desirable, because in that case the economy’s resources will not be used most effectively.
It is, thus, seen that to produce more computers, some units of cars are to be sacrificed, i.e., cars can be transformed to computers. The rate at which one product is transformed into another is called marginal rate of transformation (MRT). Thus, MRT between cars and computers is the units of cars (in our case, 5000), which has to be sacrificed for the production of computers. MRT increases, as more of one commodity is produced and less of another. This makes Production Possibility curve concave to the origin.

Uses of Production Possibility Curve

The production possibility curve has a number of uses. It helps in finding the solution of the basic problems of production—what and how to produce and for whom to produce goods in the economy. Besides, whenever government decides to divert its resources, say, from necessaries to luxuries, it may utilize the concept of production possibility curve. It can also help in guiding the diversion of resources from current consumption goods to capital goods and increase productive capacity to attain higher levels of production.


Opportunity cost is a term which means the cost of something in terms of an opportunity foregone (and the benefits that could be received from that opportunity), or the most valuable foregone alternative. In other words, the opportunity cost of a given commodity is the next best alternative cost or transfer costs. As we know that productive resources are scarce, therefore, the production of one commodity means not producing another commodity. The commodity that is sacrificed is the real cost of the commodity that is produced. This is the opportunity cost. Let us explain this with an example. Suppose a producer can produce a car or a computer with the money at his disposal. If the producer decides to produce car and not computer, then the real cost of the car is equal to the cost of computer, i.e., the alternative foregone. Let us take another example to explain the concept. For example, if a company decides to build hotels on vacant land that it owns, the opportunity cost is some other thing that might have been done with the land and construction funds instead. In building the hotels, the company has forgone the opportunity to build, say, a sporting center on that land, or a parking lot, or a housing complex, and so on. In simpler terms, the opportunity cost of spending a day for picnic with your friends could be the amount of money you could have earned if you had devoted that time to working overtime.

Opportunity cost need not be assessed in monetary terms, but rather, is assessed in terms of anything that is of value to the person or persons doing the assessing. The consideration of opportunity costs is one of the key differences between the concepts of economic cost and accounting cost. Assessing opportunity costs is fundamental to assessing the true cost of any course of action. The simplest way to estimate the opportunity cost of any single economic decision is to consider, “What is the next best alternative choice that could be made?” The opportunity cost of paying for college fee could be the ability to buy some clothes. The opportunity cost of a vacation in the Goa could be the payment for buying a motorbike.

It is to be noted that opportunity cost is not the sum of the available alternatives, but rather of benefit of the best alternative of them.

The concept of opportunity cost can be explained with a diagram that depicts opportunity cost between any two given items produced by a given economy. It is known in economics as the production possibility curve, as shown in Fig. 2.1 above. In the imaginary economy discussed above which produces only cars and computers, the economy will be operating on the PPC if all resources (inputs) are fully utilized and used most appropriately (efficiently). The exact combination of cars and computers produced depends on the mechanisms used to decide the allocation of resources (i.e., some combination of markets, government, tradition, and community democracy).

The concept of opportunity cost has become very popular in the recent years. The modern analysis of cost-benefit analysis is based on the theory of opportunity cost only. The cost-benefit analysis is a guiding tool for entrepreneurial decisions in the modern economy. Although opportunity cost can be hard to quantify, its effect is universal and very real on the individual level. The principle behind the economic concept of opportunity cost applies to all decisions, not just economic ones.