Economics 9708/12 — May/June 2015

Background Concept

Opportunity cost is a fundamental concept in economics. It refers to the value of the next best alternative that must be forgone when a choice is made. Because resources are scarce, every decision involves a trade-off. For a government project, the opportunity cost includes all the other public goods and services that could have been provided with the same resources. If the opportunity cost is too high, meaning the forgone alternatives are more valuable, then the project is not worthwhile.

Understanding the Question

The question asks for the most likely reason to abandon a government project to build a high-speed rail link. It is a multiple-choice question testing the understanding of opportunity cost. The options present different cost concepts: construction cost vs running cost (A), external cost vs external benefit (B), difficulty in calculating future costs (C), and opportunity cost (D). The correct answer is D because opportunity cost is the overarching concept that captures the sacrifice of alternatives, which is the core reason for abandoning a project when resources are scarce.

Approach

To answer this question, we need to evaluate each option in terms of economic reasoning. The most fundamental reason for abandoning a project is that the resources used could be better employed elsewhere, i.e., the opportunity cost is too high. The other options are either less fundamental or not directly relevant.

Step-by-Step Reasoning

1. Option A: "The construction cost is greater than the running cost." This compares two types of costs for the same project. Even if construction cost exceeds running cost, that does not necessarily mean the project should be abandoned; it might still be worthwhile if the benefits exceed total costs. So this is not the most likely reason.

2. Option B: "The external cost is greater than the external benefit." Externalities are important, but the question is about abandoning the project entirely. Even if external costs exceed external benefits, the project might still have private benefits that outweigh total costs. Moreover, external costs and benefits are part of a cost-benefit analysis, but the most fundamental reason is still opportunity cost.

3. Option C: "The future costs are difficult to calculate." Difficulty in calculation is a practical problem, not an economic reason for abandonment. It might lead to uncertainty, but it is not the most likely reason.

4. Option D: "The opportunity cost is too high." This is the correct answer. Opportunity cost is the value of the next best alternative forgone. If the resources used for the rail link could produce greater benefits in other uses (e.g., improving existing transport, healthcare, education), then the project should be abandoned. This is the most fundamental economic reason.

Key Takeaways

• Opportunity cost is the most important concept in decision-making under scarcity.
• When evaluating a project, the relevant cost is not just the monetary cost but the value of the best alternative forgone.
• Other cost concepts (construction cost, external cost) are secondary to opportunity cost.

Common Mistakes

• Confusing opportunity cost with monetary cost or external cost.
• Thinking that difficulty in calculating future costs is a reason to abandon a project; it is a practical issue but not an economic one.
• Not recognising that opportunity cost applies to all levels of decision-making, including government projects.

Things to Be Careful About

• Opportunity cost is not the sum of all alternatives, but the value of the single next best alternative.
• The question asks for the "most likely reason", so we need to identify the most fundamental economic reason.
• In multiple-choice questions, eliminate options that are less plausible based on economic principles.