AP® Microeconomics review sheet from Aim for Five (aimforfive.com/micro/units/1/1-1)
Unit 1 · Topic 1.1
1.1 Scarcity
Scarcity is the basic problem of economics: wants are unlimited, but the resources used to satisfy them are limited. Because you can't have everything, every choice has an opportunity cost. That idea sits under every model in the course.
Key terms
- scarcity
- trade-off
- opportunity cost
- factors of production
- capital
What scarcity means
Scarcity means there isn't enough of something to give everyone all they want at a price of zero. It's not the same as a shortage. A shortage is temporary and happens when a price is too low (you'll see it in Unit 2). Scarcity is permanent. Even a billionaire has only 24 hours in a day.
Scarcity applies to individuals, firms and whole countries. You choose between studying and sleeping. A bakery chooses between buying a new oven and hiring another worker. A government chooses between spending on roads and spending on schools. In each case, using a resource for one thing means it can't be used for something else.
Trade-offs and opportunity cost
A trade-off is giving up some of one thing to get more of another. The opportunity cost of a choice is the value of the single next-best option you give up. It's not the value of every option you passed on, just the best one you didn't pick.
Opportunity cost is not just money. If you spend Saturday at a concert instead of working a shift, the cost includes the ticket price and the wages you didn't earn. Economists count both, because both are real sacrifices.
Something can have a price of zero and still not be free. A free concert in the park still costs you the time you could have spent on something else. Economists sometimes say 'there's no such thing as a free lunch' for exactly this reason.
Factors of production
Goods and services are made with four kinds of inputs, called factors of production. All four are scarce, so using them always involves trade-offs.
| Factor | What it is | Example | Payment to its owner |
|---|---|---|---|
| Land | Natural resources in their original form | farmland, oil, timber, water | rent |
| Labor | Human work, physical or mental | a nurse's shift, a coder's hours | wages |
| Capital | Things made by people and used to make other goods | machines, tools, factories, delivery trucks | interest |
| Entrepreneurship | Organizing the other factors and taking on the risk of a business | starting a food truck | profit |
Capital is not money
In everyday speech, 'capital' often means money. In economics, capital means physical capital: tools, equipment and buildings used to produce other goods. Money itself doesn't make anything. It's only a way to buy the factors that do. So a loan to start a business is not capital, but the pizza oven bought with the loan is.
You'll also hear the term human capital, which means the skills and knowledge a worker gains through education and training. It makes labor more productive.
What isn't scarce
A few things aren't scarce in the economic sense. If one person's use doesn't leave less for anyone else, and there's enough for everyone at a price of zero, the good isn't scarce. Widely shared knowledge, such as the idea that washing your hands prevents illness, is an example. Air is often given as an example too, but clean air in a polluted city can be scarce. Ask whether using it means someone else gets less.
Worked examples
Try each one yourself first, then open the solution.
- Example 1Calculator allowed
Finding the opportunity cost of a choice
Maya can spend Saturday afternoon working a 5-hour shift at $14 an hour or going to a concert with a $40 ticket. She chooses the concert. Her third option, a nap, she values less than either. What is the opportunity cost of going to the concert?
Show the solutionHide the solution
- Step 1: Identify the next-best option: working the shift. The nap is ranked lower, so it doesn't count.
- Step 2: Count what she gives up by not working: 5 hours × $14 = $70 in wages.
- Step 3: Count the money she spends that she could have used on something else: the $40 ticket.
- Step 4: Add them: $70 + $40 = $110. The concert only makes sense if Maya values it at more than $110.
Answer: $110: the $70 in forgone wages plus the $40 ticket.
- Example 2
Sorting factors of production (classic trap)
A student opens a lemonade stand. Classify each item: (a) the $200 she borrows from her parents, (b) the folding table and juicer she buys with it, (c) the lemons, (d) her friend's paid hours squeezing lemons, (e) her work planning the business and taking the risk.
Show the solutionHide the solution
- Step 1: (a) The $200 is money, not a factor of production. It's used to buy factors. This is the trap: money is not capital in economics.
- Step 2: (b) The table and juicer are made by people and used to produce lemonade, so they are capital.
- Step 3: (c) Lemons are a natural resource used as an input, so they count as land.
- Step 4: (d) The friend's paid hours are labor.
- Step 5: (e) Organizing the business and bearing the risk is entrepreneurship.
Answer: (a) not a factor (money), (b) capital, (c) land, (d) labor, (e) entrepreneurship.
Common mistakes
- Adding up every option you didn't choose. Opportunity cost is only the value of the single next-best alternative.
- Calling money 'capital'. In economics, capital means tools, machines and buildings used in production; money just buys them.
- Mixing up scarcity and shortage. Scarcity is permanent and applies to everything with limited supply; a shortage happens when a price is held below equilibrium.
- Leaving out time. Forgone wages and time are part of the cost of a choice, even when no money changes hands.
On the exam
- Multiple-choice questions often describe a choice and ask for its opportunity cost, or ask you to classify an input as land, labor, capital or entrepreneurship.
- When an answer choice says something is 'free', check whether it still uses up time or resources; if it does, it has an opportunity cost.
Connected topics
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Check yourself
4 questions on 1.1 Scarcity. Pick an answer to see if you got it, and why.
Which of the following situations best illustrates the economic problem of scarcity?
Which of the following is an example of capital as a factor of production?
On Saturday afternoon, Maya can do only one of three things: work a 3-hour shift at $15 per hour, babysit for a neighbor for $40, or study for an exam. If Maya chooses to study, what is her opportunity cost?
Which of the following is LEAST likely to be scarce in the economic sense?
0 of 4 answered