Economics, as we have seen is a matter of choice; and each choice means that a trade off needs to made against all the alternatives not chosen.
Before one looks at how in a country economic priorities are set - let us first look at the problem of choice from an individual consumer's point of view and identify the point at which a consumer will be in equilibrium and where he has made the optimum allocation of resources. We have already said that man as a consumer has an unlimited number of wants. His resources (income) to satisfy these wants are however limited. The question now arises of how the consumer will allocate his income to optimise his need satisfaction. We assume that the individual is rational and will attempt to achieve maximum advantage - we call this the economic motive - to maximise the utility gained from the products he/she will obtain to achieve need satisfaction.
To solve these and other quandrums, economist make certain assumptions and build models to mimic and describe and predict the behaviour of the individual, the firm or for that matter the country under the given set of circumstances.
To solve the problem of how a consumer will select how he will allocate his income between say two products A and B, we will firstly assume that the prices of the goods are known and given. For the purposes of this explanation we assume that the choice for the consumer lies between two goods only. It is accepted that the two items are of such a nature that they can be divided into small quantities (like flour, sugar, even meat).
Because the price is known - a given quantity can be bought for a given amount - say 10c ...The given quantity has a certain utility and the utility of each successive quantity that can be bought for 10c reduces according to the law of diminishing marginal utility.
Let us say that the consumer has R 1,30 to spend. He spends R 1,00 on A and 30c - remember all the money must be spent. The total utility attained is 125 + 49 = 174.
It is clear to see that a greater utility can be attained if less is spent on A and more on B - so, if 90c is spent on A and 40c ob B the total utility increases to 124 + 59 = 183.
And so each time a further 10c is switched from A to B the Total utility increases up to the point where 70c is spent on A and 60c is spent on B - the total utility amounts to 191; after this point the total utility falls if there is any further shift from A to B.
At this maximum utility point the hypothesis of the economic motive is fulfilled. There is however a more general conclusion that can be drawn. That is that the total utility is at its maximum where the marginal utility of the alternatives are the same.
The conclusion that a consumer derives maximum utility from his expenditures where the marginal utilities of his purchases are the same also holds true where there are any number of goods available. this point is also called the CONSUMER EQUILIBRIUM.
Just as we have indicated that there is an optimum point between two consumer goods being consumed by an individual and how he would allocate his scarce resources - the same argument can be followed where a country is faced with the choice of producing goods with a given set of scarce resources.
Production Possibilities Frontier (to be discussed later).