Economics Online Tutor
Opportunity costs are a part of every decision that people make. In the study
of economics, a choice means selecting one alternative or option over all
other alternatives or options after weighing the benefits and costs of each
option. The option with the highest valued net benefit is the best choice.
When a choice is made, that means that all alternative options have to be
given up. These are the forgone options. Since other options are forgone, a
trade-off is involved.
The opportunity cost of a choice is the value of the next best option that
could have been made. It should be emphasized that this definition says
'value of the next best option', not 'the sum of the values of all options'. This
is because 'all other options together' is not a choice. Only one choice out of
the options can be made.
Life involves a continuous series of choices. Each choice is not made in a
vacuum, but rather becomes an additional choice to all other choices that
preceded it. When a choice is being weighed, the benefits and costs that
add to the total of all choices is considered. This means that decisions are
made "at the margin". Only marginal changes, which are called marginal
benefits and marginal costs, need to be considered. This concept hopefully
will become clearer, and will prove to be useful in the study of economics, as
the concept of opportunity costs is better understood.
Economists have developed a simplified model to illustrate and study this concept. The model is called
the Production Possibilities Curve, or PPC. Since real life economies can choose between literally
millions of different possible combinations of goods, and people cannot visualize or draw in this many
dimensions, the PPC considers only two goods at a time. This simplified model is sufficient to illustrate
the concepts involved. Also, the two goods that are considered can be aggregates, such as 'defense
spending' and 'non-defense spending', if necessary.
The PPC is a graph that shows the various combinations of two goods that a society can produce given
the current level of available resources. Any point on the curve represents a combination that is
considered efficient in the sense that it utilizes all available resources. There is no way to move away
from any point on the curve without giving up something.
Any point inside the curve is considered inefficient because not all available resources are being used:
more could be produced without giving up anything.
Any point outside the curve represents a production combination that is impossible to produce given
the current level of resources.
The PPC illustrates opportunity costs because it shows the trade-offs that are involved. On the PPC,
the only way to produce more of one good is to produce less of the other. Such a change in the
combination of the two goods would be shown as a movement from one point on the curve to another
point on the curve. The amount of one good that is given up to produce more of the other good is the
The PPC is not normally shown as a straight line, but rather as a bowed-out (convex) curve. This is due
to the concept of increasing opportunity costs. 'Increasing opportunity costs' is the concept that as
more and more resources are diverted from one activity to the other, the marginal cost of that change
in the combination that is produced becomes increasingly higher. This is due to specialization. Not all
resources used for an activity are going to be equally specialized. As resources are diverted from one
activity, the least specialized (efficient) resources would be taken away first. As more and more
resources are taken away, however, the marginal resources diverted are ones that are more and more
It was noted earlier that points outside the PPC are impossible to reach, given the current state of
resources. The only way to produce at such a level would be to increase the level of resources. When
that happens, the PPC will shift outward. If the additional resources can be used to produce only one
good, then the intercept for only that good changes, and the slope of the curve changes (changing the
opportunity cost between the two goods).
The level of resources can be increased in two ways:
More resources (quantity) can be found or created, or a better way to utilize the resources
(technological advances) can be found.
More discussion about opportunity costs can be found in the section about specialization and trade.
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