Theory question 103
Basic Concepts(a) Distinguish between: (i) money cost and opportunity cost; (ii) normal good and inferior good.
(b) Explain how the scale of preference assists the following economic groups in making efficient allocation of their resources: (i) individuals; (ii) firms; (iii) governments.
Show the model answer
(a)(i) Money cost is the amount of money paid to obtain or produce a good; opportunity cost is the next best alternative given up.
(ii) A normal good is one whose demand rises when income rises; an inferior good is one whose demand falls when income rises.
(b)(i) Individuals rank their wants and spend limited income on the most pressing ones first, getting maximum satisfaction.
(ii) Firms rank possible products/projects by expected profit and put their limited capital into the most profitable first.
(iii) Governments rank projects by importance to citizens' welfare (e.g. health, education, roads) and fund the most urgent first within the budget.
A scale of preference ranks wants so the most important are met first.