Opportunity Cost

Opportunity Cost • Does every decision you make involve trade-offs? • Questions • What is the opportunity cost of attending this economics class? • What is the opportunity cost of attending a concert by your favorite band? • What is the opportunity cost of increasing research for an AIDS vaccine?

Trade-offs and Opportunity Cost • Trade-offs are all the alternatives that we give up whenever we choose one course of action over others. • The most desirable alternative given up as a result of a decision is known as opportunity cost. All individuals and groups of people make decisions that involve trade-offs.

Limited Resources & Unlimited Wants Scarcity Choices Opportunity Cost Scarcity, Choice, and Opportunity Cost

Karen’s Decision-making Grid Alternatives Sleep late Wake up early to study Benefits Enjoy more sleep Have more energy during the day Better grade on test Teacher and parental approval Personal satisfaction Decision Sleep late Wake up early to study for test Opportunity cost Extra study time Extra sleep time Benefits forgone Better grade on test Teacher and parental approval Personal satisfaction Enjoy more sleep Have more energy during the day The Decision-Making Grid • Economists encourage us to consider the benefits and costs of our decisions.

Options 1st hour of extra study time 2nd hour of extra study time 3rd hour of extra study time Benefit Grade of C on test Grade of B on test Grade of B+ on test Opportunity Cost 1 hour of sleep 2 hours ofsleep 3 hours of sleep Thinking at the Margin • When you decide how much more or less to do, you are thinking at the margin.

Opportunity Costs • Let's say you have five dollars. What would you like to spend it on? There are a million things you would love to spend five bucks on, but let's imagine there are only three things out there you really want to buy: gum, soda, and movie tickets. Look at the price chart below and answer the questions.

Look at the price chart below and answer the questions. Good Price • Gum $ .50 • Soda $1.00 • Movie Ticket $5.00 • How many sodas can you buy instead of one movie ticket? • How many pieces of gum can you buy instead of one soda?

The World of Trade-Offs • Whenever you engage in any activity, using any resource, you are trading off the use of that resource for one or more alternative uses. • The value of the trade-off is represented by the opportunity cost, (that which you give up to obtain something else).

Identical twins Amal and Juan graduate with Bachelors degrees and receive the same job offer. Amal passes up the job offer to pursue a Masters degree while Juan takes the job offer and begins working. • Two years pass and Amal graduates and begins working. By this time Juan has been promoted to a position that is comparable to Amal’s starting position, and Juan’s salary has increased to an amount that is comparable to Amal’s starting salary.

So who made the better decision, Amal or Juan? • In business and in life, every choice we make comes at a cost since we forgo other possible alternatives in the process; this cost — whether it’s money, time, education, health, et cetera — is known as an opportunity cost. More specifically • In the example, one could argue that Amal made the better decision since a Masters degree would be valuable if both lost their jobs and found themselves in a competitive job market. Yet when you look at the situation in terms of opportunity costs, Amal’s Masters degree came at a cost of two years salary. If Amal and Juan stay on equal career paths from here on out, Juan ends up making the better decision. An opportunity cost is the value or benefit of the next best alternative.

Why is Calvin upset about the future? 2. Using the ideas of tradeoffs and opportunity cost, explain why Calvin’s final statement.

Opportunity costs even come into play in the pursuit of happiness Opportunity costs are all around us and they differ from individual to individual. Take one look at Steve Jobs and Bill Gates and think of the opportunity costs if they had decided to forgo their entrepreneurial pursuits and continue their college education instead. Things would be very different now. Ultimately, opportunity costs apply to anything which is of value to a person and being conscious of how they apply to your situation can help in making a satisfactory choice/decision by considering the value or benefit of the next best alternative.

Section 2 Assessment 1. Opportunity cost is (a) any alternative we sacrifice when we make a decision. (b) all of the alternatives we sacrifice when we make a decision. (c) the most desirable alternative given up as a result of a decision. (d) the least desirable alternative given up as a result of a decision. 2. Economists use the phrase “guns or butter” to describe the fact that (a) a person can spend extra money either on sports equipment or food. (b) a person must decide whether to manufacture guns or butter. (c) a nation must decide whether to produce more or less military or consumer goods. (d) a government can buy unlimited military and civilian goods if it is rich enough. Want to connect to the PHSchool.com link for this section? Click Here!

Production Possibilities Graphs • What is a production possibilities graph? • How do production possibilities graphs show efficiency, growth, and cost? • Why are production possibilities frontiers curved lines?

The World of Trade-Offs • Opportunity cost graphically • The production possibilities curve (PPC) represents all possible maximum combinations of total output that could be produced. • Along the production possibilities curve, there is a fixed quantity of productive resources of a given quality being used efficiently. Chapter 2 - Scarcity and the World of Trade-Offs

The classic example is “Guns v. Butter” What the heck does that mean? • It’s supposed to show that every society has to choose what to produce. • Guns represent military expenditures. • Butter represents money spent on domestic (consumer) things.

Production Possibilities Curve for Grades in Mathematics and Economics (Trade-Offs) Chapter 2 - Scarcity and the World of Trade-Offs

ProductionPossibilities Curve (PPC) • Questions • What would happen to the production possibilities curve if you spent more time studying? • What would happen to your potential grades? • Is it possible that terms of the trade-off might not be constant? Chapter 2 - Scarcity and the World of Trade-Offs

Assume a country can produce two types of goods with its resources – capital goods and consumer goods Production Possibility Frontiers If the country is at point A on the PPF It can produce the combination of Yo capital goods and Xo consumer goods Capital Goods Ym If it reallocates its resources (moving round the PPF from A to B) it can produce more consumer goods but only at the expense of fewer capital goods. The opportunity cost of producing an extra Xo – X1 consumer goods is Yo – Y1 capital goods. If it devotes all resources to capital goods it could produce a maximum of Ym. If it devotes all its resources to consumer goods it could produce a maximum of Xm A Yo B Y1 Xo X1 Xm Consumer Goods

Production Possibility Frontiers Production inside the PPF – e.g. point B means the country is not using all its resources Capital Goods C Y1 A .B Yo It can only produce at points outside the PPF if it finds a way of expanding its resources or improves the productivity of those resources it already has. This will push the PPF further outwards. Xo X1 Consumer Goods

The Choices Society Faces • Inefficient Point • Any point below the production possibilities curve at which the use of resources is not generating the maximum possible output • Law of Increasing Relative Cost • As society attempts to produce more of a good, the opportunity cost of additional units of that good generally increases • Accounts for bowed shape of the PPC Chapter 2 - Scarcity and the World of Trade-Offs

Efficiency • Anywhere on the PPF: the economy is operating at full efficiency • Somewhere inside the PPF: achievable but the economy is inefficient (not using their resources completely) • Outside the PPF: an economy can’t get there with current land, labor, and capital

The Law of Increasing Relative Cost Chapter 2 - Scarcity and the World of Trade-Offs

Economic Growth and the Production Possibilities Curve • Economic growth • Increases the production possibilities of digital cameras and pocket PCs • Occurs over a period of time • Is illustrated by an outward shift of the production possibilities curve Chapter 2 - Scarcity and the World of Trade-Offs

Growth • If immigrants pour into a country, then more labor becomes available • The maximum amount of goods the nation can produce increases • New inventions allow workers to produce more goods at lower costs

Growth • When an economy grows, the entire curve “shifts to the right” • Why???

Production Possibilities Graph 25 20 15 10 5 Watermelons (millions of tons) Shoes(millions of pairs) 0 15 8 14 c (14,12) 14 18 20 21 12 9 5 0 Shoes (millions of pairs) d (18,9) 0 5 10 15 20 25 Watermelons (millions of tons) Cost • Cost A production possibilities graph shows the cost of producing more of one item. To move from point c to point d on this graph has a cost of 3 million pairs of shoes.

Law of increasing costs • Each time we grow watermelons, the sacrifice in terms of shoes increases • This is called the law of increasing costs – as production switches from one item to another, more and more resources are necessary to increase production of the second item. • So the opportunity cost increases

Law of increasing costs • Why?? • Moving resources from factory to farm production means farmers must use resources that are not as suitable for farming • Ex: at first, use most fertile land to be growing watermelons • Over time, have to use poorer land that can produce less

Law of diminishing returns • Law of diminishing returns: output will ultimately increase by progressively smaller amounts when the use of a variable input increases while other inputs are held constant. • Does this apply in this example? What are the fixed inputs?

Shape of the curve • Law of increasing costs explains why production possibilities frontiers usually curve. • As we move along the curve, we trade off more and more to get less and less additional output.

Section 3 Assessment 1. A production possibilities frontier shows (a) farm goods and factory goods produced by an economy. (b) the maximum possible output of an economy. (c) the minimum possible output of an economy. (d) underutilization of resources. 2. An economy that is using its resources to produce the maximum number of goods and services is described as (a) efficient. (b) underutilized. (c) growing. (d) trading off. Want to connect to the PHSchool.com link for this section? Click Here!

Opportunity Cost