Opportunity Cost (Ch.1-2)
• Does every decision you make involve tradeoffs?
• How can a decision-making grid help you
identify the opportunity cost of a decision?
• How will thinking at the margin affect
decisions you make?
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.
•
The
Decision-Making
Grid
Economists encourage us to consider the benefits and
costs of our decisions.
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
Thinking at the Margin
• When you decide how much more or less to
Options
Opportunity Cost
do, you
are thinking Benefit
at the margin.
1st hour of extra
study time
Grade of C on
test
1 hour of
sleep
2nd hour of extra
study time
Grade of B on
test
2 hours of
sleep
3rd hour of extra
study time
Grade of B+ on
test
3 hours of
sleep
Cost Review
• Measure of sacrifice.
• Cost of resource is explained by demand.
• Value comes from desired uses of that
resource.
• Cost=human evaluation (Tullips)
Opportunity Cost Review
• Opportunities forgone: What you have given up to get
something.
• Money is NOT a cost!!!!!!!!!!!!!
– Way to measure cost.
– No money needs to exchange for there to be a cost (free
checking).
– Look at what is given up, not how much $ changed hands.
• SUNK COST: Once a resource is used and can’t be
recovered, it is no longer a cost, because it is no longer
a factor in future decisions (pay consequences).
(Tickets)
Sunk
vs.
Opportunity
Cost
Know consequences of decisions, don’t be dominated by sunk costs.
•
• Bad buy=cut loss right away (businesses try to minimize losses)
• Nobody sells below cost, because of opportunity costs, either you gain
something or lose all.
• Free: No scarcity, no cost (does not exist).
• Gratuitous: No monetary cost, but there are costs.
• External Cost: A cost YOU don’t bear by your decisions, but others do.
• Marginal Cost: Extra or additional cost when an additional unit is produced
Production Possibilities Graphs (Ch.13)
• What do you do with the resources you have?
• What is a production possibilities graph?
• How do production possibilities graphs show
efficiency, growth, and cost?
• Why are production possibilities frontiers
curved lines?
Production Possibilities
•
A production possibilities graph shows alternative ways that an economy can
use its resources.
The production possibilities frontier is the line that shows the maximum
Production Possibilities Graph
possible
output for that economy.
25
Watermelons
Shoes
(millions of tons) (millions of pairs)
0
15
8
14
14
12
18
9
20
5
21
0
Shoes (millions of pairs)
•
20
15
10
a (0,15)
b (8,14)
c (14,12)
d (18,9)
5
A production
possibilities frontier
e (20,5)
f (21,0)
0
5
10
15
20
25
Watermelons (millions of tons)
Efficiency
Efficiency means using resources
in such a way as to maximize the
production of goods and services.
An economy producing output
levels on the production
possibilities frontier is operating
efficiently.
Production Possibilities Graph
25
Shoes (millions of pairs)
•
20
S
15
a (0,15)
b (8,14)
c (14,12)
10
g (5,8)
d (18,9)
5
e (20,5)
A point of
underutilization
0
5
10
f (21,0)
15
20
Watermelons (millions of tons)
25
Growth
Growth If more resources become
available, or if technology
improves, an economy can
increase its level of output and
grow. When this happens, the
entire production possibilities
curve “shifts to the right.”
Production Possibilities Graph
25
Shoes (millions of pairs)
•
Future production
Possibilities frontier
T
20
S
15
a (0,15)
b (8,14)
c (14,12)
10
d (18,9)
5
e (20,5)
f (21,0)
0
5
10
15
20
Watermelons (millions of tons)
25
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
Production
Possibilities Graph
million pairs
of shoes.
25
0
15
8
14
14
12
18
9
20
5
21
0
Shoes (millions of pairs)
Watermelons
Shoes
(millions of tons) (millions of pairs)
20
15
10
c (14,12)
d (18,9)
5
0
5
10
15
20
25
Watermelons (millions of tons)
Increasing Production Possibilities
Curves
• A. More Productive Labor Force.
• B. Improve quality and quantity of capital.
• C. Improve quality and quantity of natural
resources.
• D. Improve health and education of labor.
• E. Improve technology.