Opportunity Cost

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Opportunity cost deals with providing an alternative in the PPF. If we continue with the example of colas and pizzas, the number of colas which must be scratched from production to increase pizzas is the opportunity cost of the pizzas. Alternatively to increase the total amount of colas you need to do away with production of a number of pizzas. This calculation is what encapsulates the opportunity cost. Technological resources coupled with modern tools can make this process smoother.

 In the figure given the opportunity cost can be easily determined. It is noticed that to increase production of pizza by 1 million, 3 million cans of cola need to be stopped. Hence in conclusion one pizza equates to 3 cans of coke. The data could be reversed and the calculation of opportunity cost could be calculated from Points C to D, instead of D to C. Thus to increase cola cans by 3 million, 1 million pizzas need to be cut down. Thus one can of cola is equivalent to 1/3rd of a pizza in whole.

Opportunity cost is a ratio

It can be concluded that opportunity cost is a ratio because the decrease in quantity of one commodity divided by increase of quantity of another is the opportunity cost. The calculations from points C to D or from D to C reveal that opportunity cost is 3 colas for one pizza and 1/3rd pizza for a cola. Therefore when we were comparing the cola and the pizza productions it was seen that opportunity cost of manufacturing1 can of cola was inversely equal to production of one pizza. It can be observed that opportunity cost is nothing but a ratio which can be simply obtained by a few calculations.

Increasing opportunity cost

Since it is observed that the opportunity cost of pizza is more than that of cola, it can be seen that in Fig 2.1 when the production of the two commodities, namely, pizza and cola are increased the outward bow shaped curve is different. When production of cola is increased the rate of fall of pizza is less cause the opportunity cost of cola compared to pizza is less or 1/3rd. Similarly when pizza production is increased the rate at which cola production reduces shows a steep curve as one pizza equates to 3 cans of cola. This curve can be studied in points A & B and points E & F in the figure.

It is not difficult to understand that someone who has worked for years in Dominos will have a vast knowledge in pizza production. Placing such an individual in Pepsi Co will not increase production of cola but of pizza. Therefore the greater quantity of goods one tries to produce of both pizza and cola the greater is the fall in production of additional resources which are used in the production of the goods like pizza and coke. This is directly responsible for the rise in the opportunity cost of that unit of production.

We have observed so far that production is efficient even though it is limited by different circumstances such as the production possibilities frontier. A different range of quantities can also be produced by the PPF. The question however remains how do we choose among the different PPF options as well as determine which one is the best?


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