The Law of Increasing Opportunity Cost
Unit 1: Scarcity and Opportunity Cost
I.
Bridge
Old Idea:

The production possibilities curve shows the maximum potential mixes of output for
any two goods in an economy.
New Idea:

II.
The production possibilities curve has an outward bend because opportunity costs
increase as resources are shifted from the production of an original good to the
production of a new good.
Standard Assumptions of the Production Possibilities Curve
1.
Only two goods, or categories of goods, can be produced.
2.
Resources are fixed in the short run and cannot be increased, but their use can be
shifted from the production of an original good to the production of a new good.
III.
Production Possibilities Curve Example: Part Two
Specific Assumptions and Analysis:



Assume the following resources are available and are fixed in the short run:
 Land – 1 factory, with 1 courtyard in the middle, containing 1 apple tree
 Capital – 5 cigarette machines and 5 apple bushels
 Labor – 5 workers, each capable of producing 1 carton of cigarettes per day
Assume the workers are currently producing cigarettes.
How will opportunity cost change as we shift labor toward apple production (A to F)?
Production Possibilities Schedule
1
2
3
4
5
7
8
Loss in
Apple
Opportunity
Workers Cigarette Workers
Gain in
Cigarette
Mix of
Bushels
Cost per
Producing Cartons Producing
Apple
Cartons
Output
per
Apple
Cigarettes per Day
Apples
Bushels (Opportunity
Day
Bushel
Cost)
A
5
5
0
0
B
4
4
1
2
2
1
.5
C
3
3
2
3
1
1
1
D
2
2
3
3.8
.8
1
1.3
E
1
1
4
4.5
.7
1
1.4
F
0
0
5
5
.5
1
2
1
6
Production Possibilities Curve
6
Cartons of Cigarettes
5
4
3
2
1
0
0
1
2
3
4
5
6
Bushels of Apples
IV. The Law of Increasing Opportunity Cost
law of increasing opportunity cost – opportunity cost increases as resources are shifted
from the production of an original good to the production of a new good in the short run
V.
The Law Applied to the Example
Example Explained:




We lost constant amounts of cigarettes (Column 7), but gained decreasing amounts of
apples (Column 6).
Therefore, the opportunity cost per apple bushel increased (Column 8)
Perhaps the law is better illustrated traveling the other way on the curve (F to A).
We lost increasing amounts of apples (Column 6), but gained constant amounts of
cigarettes (Column 7).
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VI. The Law Explained Again
Stated Two Simple Ways that Both Mean the Same Thing:



Constant amounts lost yield decreasing amounts gained (A).
Increasing amounts lost yield constant amounts gained (B).
A=B
Reason for the Law:

Labor becomes decreasingly productive as it is shifted from one industry to another
when the other resources are fixed in the short run.
Hypothetical Application:

Sketch a production possibilities curve if the law was called the law of constant
opportunity cost:

Sketch a production possibilities curve if the law was called the law of decreasing
opportunity cost:
VII. Guns vs. Butter
The Classic Production Possibilities Curve Example:

The classic production possibilities curve example used by economists is not cigarettes
and apples, but rather guns and butter:
Guns = Defense Goods
Butter = Nondefense Goods

It shows the opportunity cost of producing defense goods in an economy.
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