ch02 basic

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Chapter 2

Choice,

Opportunity Costsand Specialization

Economics, 7th Edition

Boyes/Melvin

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Copyright Houghton Mifflin Company. All rights reserved. 2 | 2

Opportunity Cost

Opportunity cost: the value of thehighest-valued alternative that must beforgone when a choice is made. It is theevaluation of a trade-off.

Marginal benefits and costs: the benefitsand opportunity costs associated with oneadditional unit of the good.

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Opportunity Costs and Concerts

Youve just won a free ticket to see a Madonnaconcert. U2 is performing on the same night.Tickets to see U2 cost $75. On any given day,you would be willing to pay up to $100 to see

U2. Based on this information, what is theopportunity cost of seeing Madonna? (a) $0,(b) $25, (c) $75, or (d) $100.

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Opportunity Costs

The opportunity cost of seeing Madonna is thetotal value of everything you must sacrifice toattend her concert - namely, the value to you ofattending the U2 concert. That value is $25 - the

difference between the $100 that seeing hisconcert would be worth to you and the $75 youwould have to pay for a ticket.

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Decision Making

Principle: Decision making involvestrade-offs.

A trade-off means a sacrifice--giving upone good or activity in order to obtainsome other good or activity .

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Production Possibilities Curve

The production possibilities curve showsthe maximum quantity of goods andservices that can be produced when theexisting resources are used fully andefficiently.

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Production Possibilities

Underutilized

(Inefficient)

Nondefense Goods

B1

F1C1

D1

Only nondefensegoods produced

E1

Only defensegoods produced

A1

EfficientCombinations

Defense Goods

Impossible

200

175

150

125

100

75

0

7525 50

G1

100 125

Defense Non-defense

A1 200 0

B1 175 75

C1 130 125

D1 70 150

E1 0 160F1 130 25

G1 200 75

150

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Growth

The PPC moves outward (growth occurs)as the result of: Increased resources

Larger labor force

Change in labor force participation Chance in labor-leisure decision

Improved technology (innovation)

Expansion of capital stock

An improvement in the rules (laws, institutions,and policies)of the economy

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A Shift of the PPC

Nondefense Goods

B1

C1

D1

E1

A1Defense Goods200

175

150

125

100

75

0

7525 50

B2

100 125 150

225 A2

C2

D2

E2

F2

Defense Non-defense

A2 225 0

B2 200 75

C2 175 120

D2 130 150

E2 70 160

F2 0 165

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Marginal Opportunity Cost

The Production Possibilities Curve (PPC)illustrates the concept ofopportunity cost.Each point on the PPC means that every otherpoint is a forgone opportunity.

The PPC bows outward because there areever-increasing marginal opportunity costs tothe production of any good.

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Specialization

Economic agents (individuals, firms, nations)will be better off if they choose to producethose things for which they have the lowestopportunity costs, and trade for those with

higher costs.

Agents do this because such choices involvegiving up the least amount of other things.

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Specialization & Trade

Comparative Advantage: the ability toproduce a good or service at a loweropportunity cost than someone else.

Law of comparative advantage: proposition that the joint output of trading

partners will be greatest when each good is

produced by the low opportunity cost producer.

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Private Property Rights

Private property rights are necessary for amarket economy to develop. If no one ownssomething, no one has the incentive to take careof it.

ch02 basic

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