Question

Give an example to illustrate each of the following: (a) constant opportunity costs and (b) increasing opportunity costs.

Short answer

Constant opportunity cost is when the rate of tradeoff remains the same. In case of a company producing shoes or bags, the opportunity cost would be constant if it could produce either with the same resources. The cost of one bag would always be one shoe. Increasing opportunity cost occurs when the rate of tradeoff increases. For a farmer growing wheat or rice, if more land is used for wheat, the opportunity cost in terms of rice forgone for each extra unit of wheat produced will increase.

Step-by-step solution

Define Constant Opportunity Cost

The concept of constant opportunity cost, a concept related with production possibilities frontier (PPF), suggests that as the production of one product increases, the cost of foregoing the production of the other product remains constant. In other words, the rate of tradeoff remains constant.

Example for Constant Opportunity Cost

Consider a company can either produce Shoes or Bags. Let’s say that the resources it utilizes are effectively adaptable to the production of either Bags or Shoes. Furthermore, for every pair of Shoes that the company does not produce, it creates one Bag. The opportunity cost of one bag is always one shoe and it remains constant because the resources are perfectly adaptable to producing both goods.

Define Increasing Opportunity Cost

The increasing opportunity cost on the other hand, suggests that as the production of one product increases, the cost of foregoing the production of the other product increases. In other words, the rate of tradeoff increases and the PPF is concave facing towards the origin.

Example for Increasing Opportunity Cost

A farmer decides to allocate more of his farmland to growing wheat instead of rice. Initially, when only a small proportion of land is used for wheat, the fertile land which is good for producing wheat is used. Now when more and more land is used for wheat (which is less fertile for wheat), consequently less rice is being produced. Therefore, the opportunity cost (in terms of rice forgone) for each extra unit of wheat produced will be more and more. This is known as increasing opportunity cost.

Key concepts

Constant Opportunity Cost

Understanding constant opportunity cost is essential when diving into the basics of economics and can be best explained through practical examples. Imagine a situation where you have a factory that manufactures pencils and pens. This factory has the perfect balance of resources, machinery, and skilled labor that allows for the seamless switch between producing either product. If you decide to make 100 pencils less to produce 100 more pens, the opportunity cost of pens in terms of pencils forgone stays the same: 1 pen for 1 pencil. In this scenario, the resource allocation doesn't favor the production of one item over the other; hence, the opportunity cost remains constant. This simplicity assures that the trade-offs are predictable and straightforward.

Why is this important? For decision-makers in both business and government, understanding that swapping resources between two goods won't affect their production capacity means they can make plans without worrying about inefficiencies or changing costs.

Increasing Opportunity Cost

Contrary to constant opportunity cost, increasing opportunity cost occurs when switching focus from producing one item to another becomes more costly over time. Think of a farmer with a mixed-use land that can support both potatoes and tomatoes. Initially, the farmer uses the best patches of land for tomatoes, while the rest grows potatoes. However, as the demand for tomatoes spikes, the farmer is forced to use more and more land patches that are less suitable for tomatoes. Thus, for every extra batch of tomatoes, the farmer has to sacrifice an increasingly larger quantity of potatoes. This represents an increasing opportunity cost, showcasing a common economic phenomenon: resources are often not equally suited to all tasks, and stretching them to produce more of one thing can lead to reduced efficiency and higher costs for other products.

This concept is instrumental in policy-making and business strategy, as it warns that beyond a certain point, churning out more of a good can become very expensive, impacting the overall productivity negatively.

Production Possibilities Frontier

The Production Possibilities Frontier (PPF) is a curve depicting the maximum feasible amounts of two commodities that a business can produce when resources are fixed. Casting this in a visual format, imagine a graph where the x-axis represents quantity of one good and the y-axis represents the quantity of another. The PPF is the line that defines the limits of production capability. For instance, our pencil and pen factory from earlier could be represented on a graph where every point on the line showcases a different combination of the two goods that the factory can produce at maximum efficiency. Inside the curve, production is inefficient, while points outside are unattainable with the current resources.

Understanding the PPF helps in grasping key economic concepts like efficiency, scarcity, and trade-offs. For instance, if the curve bows outwards (concave), it suggests increasing opportunity costs. Alternatively, a straight-line PPF indicates constant opportunity costs. This graphical representation helps visualize the trade-offs that economies face when allocating limited resources.

Tradeoff in Economics

A tradeoff in economics signifies the necessity to make choices between different alternatives due to scarcity of resources. Whether it's time, money, or materials, resources are limited, and opting for one course of action typically means giving up another. In our examples involving pens and pencils, and tomatoes and potatoes, each decision to produce more of one good comes at the expense of the other. This is the embodiment of a tradeoff.

Students should recognize that these tradeoffs are present in all levels of economic decision-making, from personal finance to global economic policies. When a government spends more on healthcare, it may need to reduce its investments in education. Similarly, a student who commits to extra study hours might have to trim down social activities. These decisions reflect the inherent existence of tradeoffs in every economic scenario and highlight the importance of opportunity cost in guiding these choices.