opportunity cost.teacher
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Leaders in finance, accounting
and business advice
Business Systems
Opportunity Cost
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Opportunity Cost
- The primary concern of economics is the problem of relative scarcity - resources are scarce relative to wants and therefore choices must be made.
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Opportunity Cost
- Production of one good means foregoing the production of another good.
- Similarly, consuming one good or service reduces our purchasing power and prevents us from consuming another good or service.
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Opportunity Cost
- We tend to think of the costs of a good or service in dollars, or monetary terms.
- Opportunity cost is the term used to represent the true cost of an economic decision and can be defined as the value of the next best alternative foregone.
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Opportunity Cost
- For example, $ 20 spent on a CD could have been used to buy a T-shirt. The monetary cost is $ 20 but the opportunity cost is the T-shirt.
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Opportunity Cost The concept of opportunity cost can be easily illustrated using a
model called the production possibility frontier.
- The model is a graph which shows all the combinations of
goods and services that can be produced by an economy given
the available resources and level of technology.
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Static Model
- This model is called a ‘static model’ because it refers to one point in time.
-It is assumed;
- That an economy’s resources are fixed in both quantity and quality.
- Technology is fixed.
- The economy can only produce 2 types of goods.
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Static Model
For example - assuming the economy can produce consumer and capital
goods, a production possibility schedule may look as follows:
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Static Model- The schedule can be
shown graphically and is known as ‘A Production Possibility Frontier’ or ‘Production Possibility
Curve’.
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Production Possibility Frontier or Curve
Consumer Goods
Capital Goods
15 30 45 60 75 90
20
40
60
80
100
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Production Possibility Frontier or Curve
- The production possibility frontier or curve shows all the
combinations of output an economy can
produce.
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Production Possibility Frontier or Curve
- The slope of the curve reflects the law of increasing opportunity cost -
indicating that resources are not equally suited to different types of
production.
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Production Possibility Frontier or Curve
Consumer Goods
Capital Goods
The opportunity cost of producing 100 units of Consumer Goods is?
75 = Capital Goods
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Production Possibility Frontier or Curve
Consumer Goods
Capital Goods
The opportunity cost of producing 60 units of Capital Goods is?
60 = Consumer Goods
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Production Possibility Frontier or Curve
Consumer Goods
Point H represents either
inefficient resource usage
or unemployed resources.
Capital Goods
Capital Goods
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Production Possibility Frontier or Curve
Consumer Goods
Point J is unattainable
because it lies
outside the frontier,
insufficient resources
are available.
Capital Goods
Capital Goods
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Production Possibility Frontier or Curve
Consumer Goods
Capital Goods
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Production Possibility Frontier or Curve
- New technology or resources have been discovered increasing total possible production.
- Economic Growth has taken place.
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Production Possibility Frontier or Curve
Consumer Goods
Capital Goods
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- The resource discovery or new technology is most suited to the production of capital goods.
Production Possibility Frontier or Curve
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- Is there a best place to be on the production possibility curve?
- Any point on the production possibility curve is considered efficient as all resources are being fully utilized.
Production Possibility Frontier or Curve
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Production Possibility Frontier or Curve
Consumer Goods
Capital Goods
Should an economy produce at point W?
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- Not necessarily if the economy required more consumer goods, then the economy should produce closer to the consumer goods axis. - If the economy requires more capital, then the economy would be better suited producing higher up the frontier towards the capital goods.
Production Possibility Frontier or Curve
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Leaders in finance, accounting
and business advice
Business Systems
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