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The Concept of Opportunity Cost

The Concept of Opportunity Cost. Opportunity cost of any choice What we forego when we make that choice Most accurate and complete concept of cost Opportunity cost of a choice includes both explicit costs and implicit costs Explicit cost — dollars actually paid out for a choice

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The Concept of Opportunity Cost

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  1. The Concept of Opportunity Cost • Opportunity cost of any choice • What we forego when we make that choice • Most accurate and complete concept of cost • Opportunity cost of a choice includes both explicit costs and implicit costs • Explicit cost—dollars actually paid out for a choice • Implicit cost—value of something sacrificed when no direct payment is made

  2. Opportunity Cost and Society • All production carries an opportunity cost • To produce more of one thing • Must shift resources away from producing something else

  3. Production Possibilities Frontiers (PPF) • Curve showing all combinations of two goods that can be produced with resources and technology available • Society’s choices are limited to points on or inside the PPF

  4. At point A, all resources are used for corn Quantity of corn per Period Moving from point Ato point Brequires shifting resources out of corn and into chocolate. 1,000,000 950,000 850,000 700,000 At pointF.all resources are used for chocolate. 500,000 400,000 100,000 200,000 300,000 400,000 500,000 Quantity of chocolate per Period Figure 1: The Production Possibilities Frontier A B C D E W F

  5. Increasing Opportunity Cost • According to law of increasing opportunity cost • The more of something we produce • The greater the opportunity cost of producing even more of it • This principle applies to all of society’s production choices

  6. 1. Before WWII the United States operated inside its PPF . . . Military Goods per Period 2. then moved to the PPF during the war. Both military and civilian production increased. Civilian Goods per Period Figure 2: Production and Unemployment B A

  7. Economic Growth • If economy is already operating on its PPF • Cannot exploit opportunity to have more of everything by moving to it • But what if the PPF itself were to change? Couldn’t we then produce more of everything? • This happens when an economy’s productive capacity grows • Many factors contribute to economic growth, but they can be divided into two categories • Quantities of available resources • Technological change enables us to produce more from a given quantity of resources

  8. Quantity of corn per period More corn AND More chocolate Same corn+ More chocolate Quantity of chocolate per Period Figure 3: The Effect of a New Technology to Produce Chocolate A 1,000,000 J H 700,000 D F F' 300,000 500,000 600,000

  9. Resource Allocation • Problem of resource allocation • Which goods and services should be produced with society’s resources? • Where on the PPF should economy operate? • How should they be produced? • No capital at all • Small amount of capital • More capital • Who should get them? • How do we distribute these products among the different groups and individuals in our society?

  10. The Three Methods of Resources Allocation • Traditional Economy • Resources are allocated according to long-lived practices from the past • Command Economy (Centrally-Planned) • Resources are allocated according to explicit instructions from a central authority • Market Economy • Resources are allocated through individual decision making

  11. The Nature of Markets • A market is a group of buyers and sellers with the potential to trade with each other • Global markets • Buyers and sellers spread across the globe • Local markets • Buyers and sellers within a narrowly defined area

  12. The Importance of Prices • A price is the amount of money that must be paid to a seller to obtain a good or service • When people pay for resources allocated by the market • They must consider opportunity cost to society of their individual actions • Markets can create a sensible allocation of resources

  13. Resource Ownership • Communism • Most resources are owned in common • Socialism • Most resources are owned by state • Capitalism • Most resources are owned privately

  14. Types of Economic Systems • An economic system is composed of two features • Mechanism for allocating resources • Market • Command • Mode of resource ownership • Private • State

  15. Resource Allocation Market Command CentrallyPlanned Capitalism MarketCapitalism Private Resource Ownership Centrally Planned Socialism Market Socialism State Figure 4: Types of Economic Systems

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