Basic Concepts of Economics and Allocation of Resources
The fundamental economic problem is scarcity — unlimited human wants versus limited resources — which forces every society to make choices and bear opportunity costs. The Production Possibility Curve (PPC) shows the maximum combinations of two goods an economy can produce. Resources are allocated through three questions (what, how, for whom) using different economic systems: capitalist, socialist, or mixed. Nepal follows a mixed economy.
In this chapter
Scarcity — The Root Economic Problem
Human wants are unlimited but the resources to satisfy them (land, labour, capital, entrepreneurship) are limited. This gap is called scarcity. Scarcity forces every society to choose — we cannot have everything. For example, a Nepali farmer with 1 ropani of land in Kavre must choose between growing tomatoes or potatoes; the government of Nepal must choose between spending on roads or on schools. Because of scarcity, economics is sometimes called "the science of choice".
Choice and the Three Central Questions
- What to produce? — which goods and in what quantities (e.g. should Nepal produce more rice or more hydro-electricity?);
- How to produce? — which technique, labour-intensive or capital-intensive (e.g. should farmers in Terai use tractors or bullocks?);
- For whom to produce?** — who will consume the goods, i.e. how is income distributed (rich vs poor, urban vs rural)
Opportunity Cost
Opportunity cost is the next best alternative foregone when an economic decision is made. If a student chooses to study Class 12 instead of working in a shop for Rs 8,000/month, the opportunity cost of studying is the Rs 8,000 foregone. Opportunity cost is never the sum of all alternatives — only the best one given up.
Opportunity cost formula
Opportunity cost along the PPC (slope)
Shape and Shift of the PPC
- Concave PPC (bowed outward): opportunity cost increases as we produce more of one good — the usual case (resources are not equally suited to both goods).
- Straight-line PPC: opportunity cost is constant — resources are equally productive in both goods.
- Rightward shift: economic growth — better technology, more resources, education, trade, peace. Example: Upper Tamakoshi hydropower completed → PPC of Nepal shifts rightward.
- Leftward shift: war, earthquake, flood, resource depletion. Example: 2015 Gorkha earthquake or 2017 Terai flood → PPC shifts leftward.
Movements and shifts of the PPC at a glance
| Change | Meaning | Reason / Nepal Example |
|---|---|---|
| Movement along PPC | Reallocation between two goods | Produce more rice, less wheat in Terai |
| Point inside PPC | Under-utilisation of resources | Unemployment, strike (bandh), load-shedding |
| Rightward shift | Economic growth | Upper Tamakoshi 456 MW; new irrigation canal |
| Leftward shift | Economic decline | 2015 Gorkha earthquake; 2017 Terai flood |
| Straight-line PPC | Constant opportunity cost | Resources perfectly adaptable |
| Concave PPC | Increasing opportunity cost | Resources specialised (general case) |
Specialisation and Division of Labour
Division of labour means breaking production into smaller sub-tasks, with each worker specialising in one task (e.g. one person stitches the sole, another the upper of a shoe in a Kathmandu shoe factory). Advantages: higher skill and speed, saves time, encourages innovation, use of machinery, higher output. Disadvantages: work becomes monotonous and boring, risk of unemployment if one sub-task is mechanised, loss of overall craftsmanship, over-dependence on others.
Three Economic Systems
Different societies answer the three central questions in different ways. A capitalist economy (e.g. USA) leaves decisions to the free market — prices and profits guide producers. A socialist economy (e.g. North Korea) leaves decisions to the government — central planning decides what, how and for whom. A mixed economy (e.g. Nepal, India) combines both — private sector and government work side by side. Nepal's mixed economy is visible: private companies like Ncell run telecom, but government-owned Nepal Telecom also operates; private schools coexist with community schools.
Comparison of capitalist, socialist and mixed economic systems
| Feature | Capitalist | Socialist | Mixed |
|---|---|---|---|
| Ownership of resources | Private | State (public) | Both private and state |
| Decision making | Market forces (price) | Central planning | Market + government |
| Motive | Profit maximisation | Social welfare | Profit + welfare |
| Role of government | Minimal (laissez-faire) | Total control | Regulator + producer |
| Income distribution | Unequal (rich-poor gap) | More equal | Moderate; policies reduce gap |
| Example country | USA, UK | North Korea, Cuba | Nepal, India, France |
Nepal as a Mixed Economy
Nepal's constitution declares a mixed economy. Private firms (Chaudhary Group, Dabur Nepal) coexist with state enterprises (Nepal Electricity Authority, Nepal Oil Corporation, Rastriya Banijya Bank). The government provides public goods (roads, basic health, community schools) while the private sector runs most industries and services. The 2015 Constitution specifically protects private property and allows the state to operate key public-interest enterprises.
Practice Problem
A Nepali farmer in Chitwan has 5 bigha of land and can grow either paddy or sugarcane. If he devotes all land to paddy he gets 4,000 kg; if all to sugarcane he gets 6,000 kg. (a) Draw the PPC and calculate the opportunity cost of 1 kg of paddy in terms of sugarcane. (b) Suppose a new high-yielding paddy seed raises paddy output (all-land case) to 5,000 kg. Show this as a PPC shift and explain.
Practice Problem
The 2015 Gorkha earthquake destroyed many factories, hydropower plants, irrigation canals and roads in Nepal. Using the PPC, explain: (a) the immediate effect on Nepal's PPC, (b) the long-run effect if reconstruction and foreign aid rebuild Nepal better than before ("build back better").
Quick Revision
- Scarcity = unlimited wants vs limited resources → forces choice.
- Three central questions: what, how, for whom to produce.
- Opportunity cost = next best alternative foregone; slope of PPC = OC.
- PPC concave → increasing OC; PPC straight → constant OC.
- Rightward shift = growth (better tech, more resources); Leftward shift = disaster/war.
- Capitalist = private + market; Socialist = state + planning; Mixed = both.
- Nepal = mixed economy (NEA + private ISPs; RBB + private banks).
- Division of labour: faster & skilled, but monotonous and risky if mechanised.