Opportunity Cost and Production Possibilities Overheads Opportunity Cost
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. For example, the opportunity cost of the service of an input used in the production of any particular commodity is the maximum amount that the input would produce of any other commodity.
Examples of Opportunity Cost 1. Farmer who raises hogs and considers using his own corn to feed the hogs 2. Recent college graduate who chooses a high paying job in Chicago when his family all live in Iowa and he plans to visit them once or twice a month
Examples of Opportunity Cost 3. Businessman who hires a maid to clean his house so he has time to do more consulting in the evening 4. Woman who is considering whether to stay home and take care of her children or work at a job paying $9. 50 per hour and hire a baby sitter
Examples of Opportunity Cost 5. Seamstress who chooses to make blue shirts instead of striped shirts 6. A landowner decides to farm his own land instead of renting it to a neighbor
Individuals who have a high value of time either due to high income, or personal preference - have a high opportunity cost for alternative activities
Principle of Opportunity Cost All economic decisions taken by individuals or society are costly The correct way to measure the cost of a choice is its opportunity cost — that which is given up to make the choice
The Process of Production Uses Inputs Produces Outputs
An input is a good or service that is employed in the production process Inputs are denoted by x or by x 1, x 2, … , xn
An output is a good or service that is the output of a particular production process Outputs are denoted by y or by y 1, y 2, … , ym
Production Technologies The technology set (technology for short) for a given production process is defined as the set of all input and output combinations such that the set of outputs y can be produced from the given set of inputs x
The technology set is the set of feasible input and output combinations
Inputs Used for Producing Holes in the Ground Output for the Digging Technology Some number of postholes or trenches
Elements of the Digging Technology Set
Elements of the Digging Technology Set
Inputs Used for Producing Pancakes
The Output (single) for the Pancake Technology Some number of pancakes served on a plate with butter and syrup along with a knife and fork
One Element of the Pancake Technology Set
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 Set Fix all inputs at a specific level Fix the level of y 1 at some level, say For that level of y 1, list all feasible levels of y 2 , then repeat this for all other levels of y 1.
Producible Output Set for Pancakes and Crepes pancakes 10 P(x) 5 0 0 12 14 crepes
Law of Increasing Opportunity Cost The more of something we produce, the greater is the opportunity cost of producing still more.
Vector of Inputs for Corn and Soybeans
Possible Output Combinations for Corn and Soybeans Corn Soybeans 16, 000 0 9, 600 0 4, 000 3, 000
Producible Output Set for Corn and Soybeans soybeans The Boundary of the Set is Concave 4, 000 3, 000 P(x) 0 0 9, 600 16, 000 corn
Why concavity of the boundary? Some inputs are better suited to some uses Some allocated inputs may be shared (between uses)
New Digging Technology Set 2 identical semi-skilled workers 1 shovel 1 post hole digger
Input-Output Coefficients Post Holes/Hour Trenches/Hour Shovel 4 2 Post Hole Digger 6 1/2
Some Efficient Sample Points Each worker can only use one tool 10 post holes - No trenches 0 post holes - 2. 5 trenches 6 post holes - 2 trenches 8 post holes - 1 trench 3 post holes - 2. 25 trenches
Postholes and Trenches 12 (0. 5, 9) 10 (1, 8) (1. 25, 7. 5) (2, 6) 8 6 (2. 25, 3) 4 2 0 0 0. 5 1 1. 5 2 2. 5 Trenches 3
Some Inefficient Sample Points 5 post holes - 1. 25 trenches (1/2 time on each) 4 post holes - 0. 5 trenches (“wrong” tasks) 3 post holes - 1 trench (rest 1/2 time)
Postholes and Trenches 12 (0. 5, 9) 10 (1, 8) (1. 25, 7. 5) (2, 6) 8 (1. 25, ½ each 5) 1 7/8, 2. 5 ¼ holes 6 Wrong Tasks 4 (0. 5, 4) 2 Shirk 0 0 0. 5 1 (2. 25, 3) (1, 3) 1. 5 2 2. 5 Trenches 3
Shirts with buttons on the left and on the right Buttons on right 12 Linear Producible Output Set P(x) 12 Buttons on left
Production Possibility Frontier The boundary of the producible output set is called the production possibility frontier y 1 PPF P(x) y 2
Efficient and Inefficient Points in P(x) that are on the frontier are called efficient points Points in the interior of the set P(x) are called inefficient points
We say that an input-output combination is technically efficient if the maximum possible output is being produced given the inputs. We say that an input-output combination is technically efficient if it is on the production possibility frontier.
Inefficient Production Points PPF y 1 P(x) y 2
Postholes and Trenches 12 (1, 8) 10 (1. 25, 7. 5) 8 (2, 6) 6 Wrong Tasks (2. 25, 3) 4 Wrong Division 2 Shirk 0 0 0. 5 1 1. 5 2 2. 5 Trenches 3
No Free Lunch Once we are on the production possibility frontier, we cannot produce more of one output, without producing less of another output
Postholes and Trenches 12 10 8 6 4 2 0 0 0. 5 1 1. 5 2 2. 5 Trenches 3
Postholes and Trenches 12 10 8 6 4 2 0 0 0. 5 1 1. 5 2 2. 5 Trenches 3
A Free Lunch If we are at a point in the producible output set that is not on the boundary, then we can get more output from the same input bundle and thus there is a “free lunch. ”
Postholes and Trenches 12 (0. 5, 9) 10 (1, 8) (1. 25, 7. 5) 8 (2, 6) 6 Wrong Tasks (2. 25, 3) 4 Wrong Division 2 Shirk 0 0 0. 5 1 1. 5 2 2. 5 Trenches 3
The End
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