“The Opportunity Cost of a product is the return that can be had from the next best alternative use.” Explain this statement using Production Possibility Curve.
Ans:
The opportunity cost of anything is the return that can be
had from the next best alternative use. A farmer who is producing wheat can also produce potatoes
with the same factors. Therefore, the opportunity cost of a quintal of wheat is the amount of the
output of potatoes given up. The opportunity costs are the ‘costs of sacrificed alternatives.’Whenever
the manager takes a decision he chooses one course of action,sacrificing the other alternative courses.
We can therefore evaluate the one, which is chosen in terms of the other (next best) alternative that is
sacrificed. A machine can produce either X or Y. The opportunity cost of producing a given quantity of Xis
the quantity of Y which it would have produced. The opportunity cost of holding Rs.1000 as cash in hand for
one year is the 10%rate of interest, which would have been earned had
it been invested in the form of fixed deposits in the bank.
•all decisions which involve choice must involve opportunity
cost calculation,
•the opportunity cost may be either real or monetary, either
implicit or explicit,
either non-quantifiable or quantifiable.Opportunity costs’ relevance is not limited
to individual decisions. Opportunity cost are also relevant to government’s decisions, which affect
everyone in society. A common example is the guns-versus-butter debate. The resources that a society has
are limited; therefore its decisions to use those resources to have more guns(more weapons) means that
it must have less butter (fewer consumer goods). When society decides to spend 100 crore on developing a
defence system, the opportunity cost of that decision is 100 crores not spent on fighting drugs,
helping the homeless, or paying off some of the national debt. For the country as a whole, the production possibility reflects
opportunity costs.
Figure 2.1 shows the Production Possibility Curve
(PPC) reflecting the different combinations of goods, which an economy can
produce, given its state of technology and total resources. It illustrates
the menu of choices open to the economy. Let us take the example that the
economy can produce only two goods, butter and guns. The economy can
produce only guns, only butter or a combination of the two, illustrating the
trade offs or choice inherent in such a decision. The opportunity cost of
choosing guns over butter increases as the production of guns is increased. The
reason is that some resources are relatively better suited to producing
guns. The quantity of butter, which has to be sacrificed to produce an additional
unit of guns, is called the opportunity cost of guns (in terms of
butter).Due to the increasing opportunity cost of guns, the PPC curve will be
concave to the origin. Increasing opportunity cost of guns means that to
produce each additional unit of guns, more and more units of butter have to be
sacrificed. The basis for increasing opportunity costs is the following
assumptions :i) Some factors of production are more efficient in the
production of butter and some more efficient in production of guns. This
property of factors is called specificity. Thus specificity of factors of
production causes increasing opportunity costs.
ii) The
production of the goods require more of one factor than the other. For example, the production of guns may require more capital than that of
butter. Hence, as more and more of capital is used in the
manufacture of guns, the opportunity cost of guns is
likely to increase. Let us assume that an economy is at point A where it uses
all its resources in the production of butter.
Starting from A, the production of 1 unit of guns requires that AC units of butter be given up. The production of a second unit of guns
requires that additional CD units of butter be given up. A third requires that DE be given up, and so on. Since DE>CD>AC, and so on, it means that for every additional
unit of guns more and more units of butter will have to be
sacrificed, or in other words, the opportunity cost keeps on
increasing. The opportunity cost of the first few units of guns would
initially be low and those resources, which are more
efficient in the production of guns move from, butter production to gun production. As more and more units of guns are
produced, however, it becomes necessary to move into gun production,
even for those factors, which are more efficient in
the production of butter. As this happens, the opportunity cost
of guns gets larger and larger. Thus, due to increasing opportunity costs the PPC is concave. If the PPC curve were to be a
straight line, the opportunity cost of guns would always be
constant. This would mean equal (and not increasing amounts of butter) would have to be forgone to produce an additional unit of guns. The
assumption of constant opportunity costs is very unrealistic. It
implies that all the factors of production
are equally efficient either in the production of butter or in the production of guns. For many of the choice society make opportunity costs tend
to increase as we choose more and more of an item. Such a phenomenon about
choice is so common, in fact, that it has acquired a name: the principle of increasing
marginal opportunity cost. This principle states that in order to get more of
something, one must give up ever-increasing quantities
of something else. In other words, initially the opportunity costs of an activity are low, but they increase the more we concentrate
on the activity.
“The Opportunity Cost of a product is the return that can be had from the next best alternative use.” Explain this statement using Production Possibility Curve.
Reviewed by enakta13
on
November 25, 2013
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