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Opportunity Cost and Production Possibilities Overheads. Opportunity Cost. The opportunity cost of any choice is what we give up when we make that choice. The opportunity cost of any good or service is its value in its next best alternative use . - PowerPoint PPT Presentation
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Opportunity Cost and Production Possibilities
Overheads
Opportunity CostOpportunity Cost
The The opportunity costopportunity cost of any choice of any choiceis what we give up when we makeis what we give up when we makethat choicethat choice
The The opportunity costopportunity cost of any good or of any good or serviceservice
is its value in its next best alternative useis its value in its next best alternative use ..
For example, the For example, the opportunity costopportunity cost of the of the
service of an service of an inputinput used in the production used in the production
of any particular commodity is the of any particular commodity is the
maximum maximum amount that the input would amount that the input would
produceproduce of any other commodity. of any other commodity.
Examples of Opportunity CostExamples of Opportunity Cost
1.1. Farmer who raises hogs and considers Farmer who raises hogs and considers using his own corn to feed the hogsusing his own corn to feed the hogs
2.2. Recent college graduate who chooses Recent college graduate who chooses a high paying job in Chicago when his a high paying job in Chicago when his family all live in Iowa and he plans to family all live in Iowa and he plans to visit them once or twice a monthvisit them once or twice a month
3.3. Businessman who hires a maid to clean his Businessman who hires a maid to clean his house so he has time to do more consulting house so he has time to do more consulting in the eveningin the evening
4.4. Woman who is considering whether to Woman who is considering whether to stay home and take care of her childrenstay home and take care of her childrenor work at a job paying $9.50 per houror work at a job paying $9.50 per hourand hire a baby sitterand hire a baby sitter
Examples of Opportunity CostExamples of Opportunity Cost
5.5. Seamstress who chooses to make blue Seamstress who chooses to make blue shirts instead of striped shirtsshirts instead of striped shirts
66.. A landowner decides to farm his A landowner decides to farm his own land instead of renting it to a own land instead of renting it to a neighborneighbor
Examples of Opportunity CostExamples of Opportunity Cost
Individuals who have a high value of time - Individuals who have a high value of time -
either due to high income, either due to high income, or personal preferenceor personal preference
- have a high opportunity cost for- have a high opportunity cost foralternative activitiesalternative activities
All economic decisions taken by individuals All economic decisions taken by individuals or society are costly or society are costly
Principle of Opportunity CostPrinciple of Opportunity Cost
The correct way to measure the cost of a The correct way to measure the cost of a choice is its opportunity cost — choice is its opportunity cost —
that which is that which is given upgiven up to make the choice to make the choice
The Process of Production
Uses Inputs
Produces Outputs
An input is a good or service that An input is a good or service that
is employed in the production is employed in the production
processprocess
Inputs are denoted by x or byInputs are denoted by x or byxx11, x, x22, … , x, … , xnn
An output is a good or serviceAn output is a good or service
that is the outputthat is the output
of a particular production process of a particular production process
Outputs are denoted by y or byOutputs are denoted by y or byyy11, y, y22, … , y, … , ymm
Production TechnologiesProduction Technologies
The The technology settechnology set (technology for short) (technology for short)
for a given production process is defined for a given production process is defined
as the set of as the set of all input and output all input and output
combinationscombinationssuch that the such that the set of outputs yset of outputs y
can be produced fromcan be produced from
the given set of the given set of inputs xinputs x
The technology set is the set of The technology set is the set of
feasible input and output feasible input and output
combinationscombinations
Inputs Used for Producing Holes in the GroundInputs Used for Producing Holes in the Ground
shovel semi skilled labor
Output for the Digging TechnologyOutput for the Digging Technology
Some number of postholes or trenchesSome number of postholes or trenches
1 shovel 1 hour semi skilled labor
4 postholes 0 trenches
Elements of the Digging Technology SetElements of the Digging Technology Set
1 shovel 1 hour semi skilled labor
0 postholes 2 trenches
1 shovel 1 hour semi skilled labor
2 postholes 1 trenches
Elements of the Digging Technology SetElements of the Digging Technology Set
powdered milk water eggs oilflour baking powder salt bowlwhip measuring set cup spatula
small griddle camp stove white gas matchessemi skilled labor butter maple syrup
plate knife fork
Inputs Used for Producing PancakesInputs Used for Producing Pancakes
The Output (single) for the Pancake TechnologyThe Output (single) for the Pancake Technology
Some number of pancakes served Some number of pancakes served on a plate with butter and syrup on a plate with butter and syrup along with a knife and forkalong with a knife and fork
One Element of the Pancake Technology SetOne Element of the Pancake Technology Set
1/3c powdered milk 15/16c water 1egg 2Toil
1c flour 2t baking powder 1/4t salt 1bowl
1whip 1measuring set 1 cup 1 spatula
1small griddle 1camp stove 1/4c white gas 2matches
1/4 h semi skilled labor 3Tbutter 1/2c maple syrup
1plate 1knife 1fork
10 pancakes
The Producible Output Set P(x)The Producible Output Set P(x)
The producible output set P(x)
is the set of all combinations of outputs,
that are obtainable from a fixed level of inputs.
Construction of the Producible Output SetConstruction of the Producible Output Set
Fix all inputs at a specific level
x ( x1, x2, x3, , xn)
For that level of y1, list all feasible
levels of y2 , then repeat this for all other
levels of y1.
Fix the level of y1 at some level, say y1
pancakes
crepes
P(x)
Producible Output Set for Pancakes and CrepesProducible Output Set for Pancakes and Crepes
5
12 14
10
00
Law of Increasing Opportunity CostLaw of Increasing Opportunity Cost
The more of something we produce,The more of something we produce,
the greater is the opportunity costthe greater is the opportunity costof producing still more.of producing still more.
200 acres land 20,000 lbs nitrogen 1 combine 1 grain head 1 corn head
15 hrs labor per month 1 tractor 1 disk 1 planter 1 rotary hoe
400 gallons diesel 1 row cultivator 1 wagon 1 hand hoe 1 butterfly net
60 bags corn seed 120 bags soybean seed
Vector of Inputs for Corn and SoybeansVector of Inputs for Corn and Soybeans
Possible Output Combinations for Corn and SoybeansPossible Output Combinations for Corn and Soybeans
CornCorn SoybeansSoybeans
16,00016,000 0 0 00 4,000 4,000
9,6009,600 3,000 3,000
soybeans
corn
P(x)
Producible Output Set for Corn and SoybeansProducible Output Set for Corn and Soybeans
16,000
4,000
9,600
3,000
0
The Boundary of the Set is Concave
0
Why concavity of the boundary?
Some inputs are better suited to some uses
Some allocated inputs may be shared(between uses)
New Digging Technology SetNew Digging Technology Set
2 identical semi-skilled workers
1 shovel 1 post hole digger
Input-Output CoefficientsInput-Output Coefficients
Shovel
Post Holes/Hour Trenches/Hour
4 2
Post Hole Digger
6 1/2
Some Efficient Sample PointsSome Efficient Sample Points
Each worker can only use one tool
10 post holes - No trenches
6 post holes - 2 trenches
0 post holes - 2.5 trenches
8 post holes - 1 trench
3 post holes - 2.25 trenches
0
2
46
8
10
12
0 0.5 1 1.5 2 2.5 3
Trenches
Post
hole
sPostholes and Trenches
(2,6)
(1,8)
(2.25, 3)
(1.25,7.5)(0.5, 9)
Some Inefficient Sample PointsSome Inefficient Sample Points
5 post holes - 1.25 trenches
3 post holes - 1 trench
4 post holes - 0.5 trenches
(1/2 time on each)
(“wrong” tasks)
(rest 1/2 time)
Wrong Tasks¼ holes
0
2
46
8
10
12
0 0.5 1 1.5 2 2.5 3
Trenches
Post
hole
sPostholes and Trenches
(2,6)
(1,8)
(2.25, 3)
(1, 3)
(1.25, 5)½ each1 7/8, 2.5
(0.5, 4)Shirk
(1.25,7.5)(0.5, 9)
Buttons on right
Buttons on left
Shirts with buttons on the left and on the rightShirts with buttons on the left and on the right
P(x)
Linear Producible Output Set12
12
Production Possibility FrontierProduction Possibility FrontierThe boundary of the producible output set is calledThe boundary of the producible output set is calledthe production possibility frontierthe production possibility frontier
P(x)
y1
y2
PPF
Efficient and Inefficient PointsEfficient and Inefficient Points
Points in P(x) that are on the frontier are called efficient pointsPoints in P(x) that are on the frontier are called efficient points
Points in the interior of the set P(x) are called inefficient pointsPoints in the interior of the set P(x) are called inefficient points
We say that an input-output combination is We say that an input-output combination is technically efficienttechnically efficient if the maximum possible output is being produced given the inputs.if the maximum possible output is being produced given the inputs.
We say that an input-output combination is We say that an input-output combination is technically efficienttechnically efficientif it is on the production possibility frontier.if it is on the production possibility frontier.
P(x)
y1
y2
PPF
Inefficient Production PointsInefficient Production Points
0
2
46
8
10
12
0 0.5 1 1.5 2 2.5 3
Trenches
Post
hole
sPostholes and Trenches
(2,6)
(1,8)
(2.25, 3)Wrong Tasks
Shirk
(1.25,7.5)
Wrong Division
Once we are on the production possibility frontier, Once we are on the production possibility frontier,
No Free LunchNo Free Lunch
we cannot produce more of one output,we cannot produce more of one output,
without producing less of another outputwithout producing less of another output
0
2
46
8
10
12
0 0.5 1 1.5 2 2.5 3
Trenches
Post
hole
sPostholes and Trenches
0
2
46
8
10
12
0 0.5 1 1.5 2 2.5 3
Trenches
Post
hole
sPostholes and Trenches
A Free LunchA Free Lunch
If we are at a point in the producible output setIf we are at a point in the producible output setthat is not on the boundary,that is not on the boundary,
then we can get more output from the then we can get more output from the same input bundle and thus there is a “free same input bundle and thus there is a “free lunch.”lunch.”
0
2
46
8
10
12
0 0.5 1 1.5 2 2.5 3
Trenches
Post
hole
sPostholes and Trenches
(2,6)
(1,8)
(2.25, 3)Wrong Tasks
Shirk
(1.25,7.5)
Wrong Division
(0.5, 9)
The End
