Home › Topics › Scarcity & trade-offs
MICROECONOMICSScarcity, trade-offs and comparative advantage
Economics starts with a fact of life: you can't have everything. Scarcity forces choices, and every choice has a price, measured in what you give up.
Scarcity and opportunity cost
Scarcity means wants exceed the resources available to satisfy them. Opportunity cost is the value of the next-best alternative you give up, not all of them, and not only money. If an assignment takes 4 hours and an episode of a show takes 1 hour, one assignment costs 4 episodes.
The production possibilities frontier
A PPF shows the maximum combinations of two goods you can produce with given resources and technology. Points on the curve are efficient, points inside waste resources, and points outside are out of reach for now.
- A straight PPF means constant opportunity cost, because resources are equally good at both jobs.
- A PPF that bows outward means increasing opportunity cost: resources are better suited to one good, so the more you specialize, the more you give up per extra unit.
- Growth or better technology shifts the frontier outward.
For a longer worked treatment, see the blog post The shape of scarcity.
Comparative advantage: a worked example
You and your roommate each split a week between making pizzas and making playlists.
| Max pizzas | Max playlists | Cost of 1 pizza | Cost of 1 playlist | |
|---|---|---|---|---|
| You | 10 | 5 | 0.5 playlist | 2 pizzas |
| Roommate | 4 | 4 | 1 playlist | 1 pizza |
You have an absolute advantage in both goods, since you can make more of each. But comparative advantage depends on opportunity cost: you give up less to make pizza (0.5 versus 1 playlist), and your roommate gives up less to make playlists (1 versus 2 pizzas).
So you specialize in pizza, your roommate in playlists, and you trade. Any price for a playlist between 1 and 2 pizzas works. At 1.5 pizzas per playlist you pay less than the 2 pizzas it would cost you to make one yourself, and your roommate earns more than the 1 pizza they give up. Both are better off.
Common exam traps
- Mixing up absolute and comparative advantage. Trade can help even when one party is better at everything.
- Stating opportunity cost in the wrong good. The cost of a pizza is measured in playlists, and the reverse.
- Treating a point inside the PPF as efficient.
Slide along the frontier, shift it, and see who has the comparative advantage.
Open the thinking lab →