Opportunity cost is a foundational concept in microeconomics and is key to understanding how the Production Possibilities Curve (PPC) illustrates economic trade-offs and decision-making. It allows economists and students alike to examine the cost of choices in a world of scarce resources and competing needs.
What Is Opportunity Cost?
Opportunity cost is defined as the value of the next best alternative foregone when a decision is made. In other words, it's the benefit that is lost when choosing one option over another. In economics, we assume that resources—such as time, money, land, and labor—are limited, so choosing to use these resources for one activity typically means giving up the chance to use them for something else.
This concept is not limited to money. For example, if a student spends one hour studying for economics instead of going to the gym, the opportunity cost is the health benefit or enjoyment the student would have gained from exercising.
In the context of the Production Possibilities Curve (PPC), opportunity cost refers specifically to the quantity of one good or service that must be sacrificed to produce more of another. This trade-off can be observed directly on the PPC, where producing more of one good results in less of the other due to the economy's limited resources and technology.
Using the PPC to Calculate Opportunity Cost
The PPC is a valuable graphical tool that helps students and economists visualize and compute opportunity cost. It shows all possible combinations of two goods that a country, business, or individual can produce when all resources are fully and efficiently used. By analyzing movement along the curve, we can identify how much of one good must be given up to produce more of the other.
Key Steps for Calculating Opportunity Cost from the PPC
Identify the two goods being compared. These can be anything the economy is producing—such as consumer goods and capital goods, or trucks and food.
Select two points on the PPC that show a change in production from one combination to another.
Calculate the change in the quantities of each good.
Apply the opportunity cost formula, which is:
Opportunity cost of Good A = (Loss in quantity of Good B) divided by (Gain in quantity of Good A)
This equation gives the opportunity cost of producing one unit of Good A in terms of how much of Good B is sacrificed.
This basic formula helps break down what appears to be a complex concept into simple arithmetic, enabling students to compute and interpret opportunity cost from graphs and tables.
Example 1: Using a Table to Calculate Opportunity Cost
Suppose a country is producing two goods: computers and wheat. Consider two production points on the PPC:
Point X: 100 computers and 300 tons of wheat
Point Y: 120 computers and 240 tons of wheat
By moving from Point X to Point Y, the economy increases production of computers by 20 units. However, it produces 60 fewer tons of wheat. The opportunity cost of producing these 20 additional computers is the 60 tons of wheat that must be given up.
To find the opportunity cost of 1 computer:
Opportunity cost = 60 (wheat) ÷ 20 (computers) = 3 tons of wheat per computer
This means that for each additional computer produced, the economy must give up 3 tons of wheat.
Constant vs. Increasing Opportunity Cost
The shape of the PPC helps us determine whether opportunity costs are constant or increasing. Although more detailed discussions of the PPC’s shape are included in another section of the syllabus, we will explore how these shapes affect opportunity cost calculations.
Constant Opportunity Cost
Constant opportunity cost occurs when the PPC is a straight line. This implies that resources are equally adaptable to producing both goods. For example, if a worker can produce either 1 book or 1 pen with the same amount of time and skill, shifting between the two will not increase the opportunity cost.
Example of Constant Opportunity Cost
Suppose a country can produce only two goods: books and pens. The following combinations of production are available:
Combination A: 0 books and 100 pens
Combination B: 10 books and 90 pens
Combination C: 20 books and 80 pens
From Combination A to B:
Gain of 10 books
Loss of 10 pens
Opportunity cost = 10 pens ÷ 10 books = 1 pen per book
From Combination B to C:
Gain of 10 books
Loss of 10 pens
Opportunity cost = 10 pens ÷ 10 books = 1 pen per book
The opportunity cost remains constant as production shifts from one good to another. This is characteristic of a straight-line PPC, which assumes all resources are equally efficient in the production of both goods.
Increasing Opportunity Cost
In most real-world scenarios, opportunity costs increase as more of one good is produced. This is illustrated by a bowed-out PPC, where the curve becomes steeper as you move along it. This shape reflects the idea that resources are not perfectly adaptable to all types of production. Some resources are better suited for producing one good than the other.
Example of Increasing Opportunity Cost
Assume a PPC for the production of trucks and bicycles, showing the following combinations:
Point A: 0 trucks, 100 bicycles
Point B: 1 truck, 95 bicycles
Point C: 2 trucks, 85 bicycles
Point D: 3 trucks, 70 bicycles
From Point A to B:
Gain of 1 truck
Loss of 5 bicycles
Opportunity cost = 5 bicycles per truck
From Point B to C:
Gain of 1 truck
Loss of 10 bicycles
Opportunity cost = 10 bicycles per truck
From Point C to D:
Gain of 1 truck
Loss of 15 bicycles
Opportunity cost = 15 bicycles per truck
As we produce more trucks, we must give up increasing numbers of bicycles. The opportunity cost is increasing with each additional truck. This happens because the resources that were best suited for making bicycles are now being shifted toward truck production, where they are less efficient.
This rising cost reflects a common trade-off in economics: the more you specialize, the more it costs to continue expanding production.
Visual Interpretation of Opportunity Cost on the PPC
The slope of the PPC at any point represents the opportunity cost of the good on the horizontal axis. A steep slope means a high opportunity cost, while a flat slope means a lower opportunity cost.
If the PPC is a straight line, the slope is constant, and the opportunity cost remains the same.
If the PPC is bowed out, the slope increases as you move along the curve, indicating increasing opportunity costs.
If the PPC is bowed in (a rare case), the slope decreases as you move along, indicating decreasing opportunity costs.
The slope of the PPC is often referred to as the marginal rate of transformation (MRT). It shows the rate at which one good must be given up to produce more of the other and reflects the opportunity cost at the margin.
Understanding the MRT is crucial for interpreting how changes in production affect opportunity costs and overall efficiency.
Calculating Opportunity Cost from Data Tables
When given numerical data in a table format, students can calculate opportunity cost using the same method as with a graph: track the changes in quantities and divide the loss of one good by the gain of the other.
Sample Data Example
Let’s say a country can produce apples and oranges, and the production combinations are as follows:
Combination A: 0 apples, 100 oranges
Combination B: 10 apples, 90 oranges
Combination C: 20 apples, 70 oranges
Combination D: 30 apples, 40 oranges
From A to B:
Gain of 10 apples
Loss of 10 oranges
Opportunity cost = 10 ÷ 10 = 1 orange per apple
From B to C:
Gain of 10 apples
Loss of 20 oranges
Opportunity cost = 20 ÷ 10 = 2 oranges per apple
From C to D:
Gain of 10 apples
Loss of 30 oranges
Opportunity cost = 30 ÷ 10 = 3 oranges per apple
This is a clear example of increasing opportunity cost. As the country produces more apples, it must give up increasingly large amounts of oranges.
Practical Tips
Always include units: When calculating opportunity cost, write your answer in terms of units (e.g., "3 tons of wheat per computer").
Double-check the direction: Make sure you understand whether you're calculating the cost of gaining or losing a particular good.
Understand the context: Know whether you're dealing with constant or increasing opportunity cost. This affects how you interpret the data.
Label your axes carefully: In graph problems, always be sure which good is on which axis. The opportunity cost of the good on the horizontal axis is reflected in the slope of the PPC.
Use margins: In some questions, you're asked for the opportunity cost "at the margin" (for one additional unit). Use small movements between points to answer these accurately.
FAQ
Opportunity cost is never truly zero on a PPC when resources are scarce and fully employed. Since the PPC represents trade-offs in a world with limited resources, producing more of one good always requires giving up some of another. However, opportunity cost can appear to be zero in specific cases—such as when moving from a point inside the PPC to a point on the PPC. This movement represents better utilization of underused resources, so production of both goods can increase without any trade-off. In that case, no resources are being reallocated; they’re simply being used more efficiently. But once the economy is operating on the curve—meaning full employment and efficient use of all resources—opportunity cost becomes unavoidable. Additionally, in a hypothetical scenario where resources are perfectly abundant (which doesn’t reflect real-world conditions), opportunity cost might not exist, but this lies outside the PPC’s intended framework.
Marginal opportunity cost refers to the opportunity cost of producing one additional unit of a good, whereas total opportunity cost refers to the cumulative amount of the other good that must be given up when producing a larger quantity. On a PPC, marginal opportunity cost is often represented by the slope at a specific point or between two close points, showing the cost of a small change in production. This is especially useful when analyzing decisions at the margin, a key principle in microeconomics. Total opportunity cost, on the other hand, is useful when evaluating a full shift from one production point to another across a larger range. For example, if moving from producing 0 to 5 units of Good A causes a loss of 25 units of Good B, the total opportunity cost is 25 units, while the marginal opportunity cost at each step may vary, particularly if the PPC is bowed out. Understanding this difference is essential for accurate cost-benefit analysis.
The law of increasing opportunity cost occurs because resources are not equally efficient or adaptable for producing all goods. As production shifts from one good to another, increasingly less-suitable resources must be reallocated, making each additional unit more "expensive" in terms of what must be given up. For instance, a worker highly skilled in textile manufacturing might be reassigned to produce electronics. While the first few shifts in production might involve workers or capital that can efficiently adapt to the new good, eventually the economy must use resources that are much less suited to the task. This reallocation reduces overall productivity and causes greater losses in the good being sacrificed. This results in the PPC bending outward and becoming steeper as more of one good is produced. The steepening slope represents the rising marginal opportunity cost of continuing to specialize, illustrating a fundamental trade-off in resource use.
Comparative opportunity cost refers to the opportunity cost of producing one good in terms of another, and it plays a crucial role in determining comparative advantage. Even though this ties into trade theory more broadly, understanding how to extract comparative opportunity costs from a PPC is essential. To calculate it, you take the opportunity cost for one good (how much of the other good must be given up to produce it) and compare it across producers. For example, if Country A’s PPC shows that 1 ton of wheat costs 2 tons of corn, and Country B’s PPC shows that 1 ton of wheat costs 3 tons of corn, then Country A has the lower opportunity cost of producing wheat. Therefore, Country A has a comparative advantage in wheat. Even without actual international trade context, PPCs can be used to compare opportunity costs between individuals, firms, or regions, revealing who should specialize in what for maximum efficiency.
Yes, the steepness or flatness of a PPC at a specific point directly reflects the marginal opportunity cost of the good on the horizontal axis. A steep slope means a high opportunity cost—you must give up a lot of the good on the vertical axis to produce one more unit of the good on the horizontal axis. A flatter slope means a low opportunity cost—less of the other good is sacrificed. This is especially relevant when the PPC is bowed out, showing increasing opportunity cost. The slope varies at each point along the curve, and students must be aware that moving from left to right along the PPC (increasing one good) typically means rising marginal opportunity cost. This visual cue helps in identifying which production choices are more costly and in understanding why certain trade-offs may no longer be beneficial. For accurate opportunity cost calculations, always evaluate the steepness between two points, not just their positions.
Practice Questions
A country can produce either wheat or cars using all of its available resources. Moving from point A to point B on the country’s production possibilities curve (PPC), wheat production decreases from 100 units to 80 units while car production increases from 10 units to 20 units. Calculate the opportunity cost of producing one additional car and explain what this implies about the country’s resource allocation.
The opportunity cost of producing one additional car is 2 units of wheat. This is calculated by taking the loss in wheat (100 - 80 = 20 units) and dividing by the gain in cars (20 - 10 = 10 cars), which equals 2 wheat per car. This implies that for each additional car produced, the country must reallocate resources away from wheat production, sacrificing 2 units of wheat. The fact that this opportunity cost is constant suggests that the country’s resources are equally adaptable for producing both goods, and the PPC in this scenario is likely a straight line
Assume an economy can produce only corn and cotton. Between two production points, the economy increases corn production from 50 units to 70 units while cotton production decreases from 200 units to 140 units. Based on this information, determine whether the opportunity cost is increasing or constant. Justify your answer.
The opportunity cost of producing 20 additional units of corn is 60 units of cotton (200 - 140), or 3 cotton per unit of corn. Without additional data showing changes in opportunity cost across more intervals, we cannot conclusively determine if opportunity cost is increasing. However, if this trend continues—where each additional unit of corn requires a larger sacrifice of cotton—then opportunity cost would be increasing. This would indicate that resources are not equally suited for both goods. In this specific scenario, we can only describe the opportunity cost at the margin, which is 3 cotton per corn.
