Human
wants are unlimited and the resource to satisfy the wants are strictly limited
is the basic economic problem. This
became a problem because of the following conflicts. i.e. 1) Individuals want to maximize their
satisfaction or pleasure. 2) Firms want
to maximize their profit. 3) Governments
want to maximize the welfare of the people.
The
decision to utilise the scarce resources to produce goods and services to
satisfy maximum wants is known as resources
allocation. The
allocation of resources is important for economy or a firm or an individual
because of the scarcity of resources. Scarcity of a thing means
that the thing is not available in required quantity. These scarce resources
will have alternative uses.
The
decision for Resources allocation of an economy or a firm or an individual is
done based on the following questions
1) What to produce? 2) How to produce?
3) Where to produce? 4) To whom to produce?
The
answer for the above questions are considered on the basis of
opportunity cost. Since the wants are unlimited, and the resources to
satisfy the wants are limited one should choose from alternatives.
Where
Choice means, the selection of
some wants from among a set of different wants.If
the initial allocation is not able to economise the resources so as to maximize
satisfaction, profit and the welfare at its proper desired combination, then
the resources are to be reallocated. Reallocation of resources refers to the withdrawal of
resources from unproductive sectors and using in the productive sectors which
gives maximize a desired combination of satisfaction, profit and the
welfare
Choice and order of preference
We
have to list our unlimited wants in their order of preferences and choose the
most important one. We have to leave the next best item from
our list of preference. In
Economics, opportunity cost [next best alternative forgone]
is very important because, the cost of a scarce resource cannot be calculated in terms of money because it
is scarce and it has alternative uses. So it can only be calculated
in terms of the next best alternative forgone. Alternative means other possibility
or option. (There will be either one of two or one of several,
things or courses of action to choose between). For example “a
piece of land” (Scarce resource) could be used for various purposes, i.e. 1)
Used for constructing a school, 2) Used for a children’s park, 3) Used for construction of an office or 4) Used for building a
house.
These
are the four alternative uses of that piece of land. To find
out the opportunity cost, make a list of other uses of the land in the order of preference, i.e. 1) a school,
2) a children’s park, 3) an office and 4) a house building. From
the list of preferences if one choose the first option, i.e. a school the
opportunity cost of using the land for a school is the next best alternative
from the list of preferences i.e. a children’s park.
Opportunity cost is the next best alternative forgone. The
concept of opportunity cost may be explained using the following
diagram.
Opportunity cost concept may be described
using a diagram, it is known as opportunity cost curve. Since it shows the maximum possible
production with existing available resource, it is called as Production possibility curve.
This Curve shows the process of transformation of resources into final
products, it is also known as transformation curve.
Using
all the resources, the economy can produce OA amount of Capital goods or OB
amount of consumer goods. That means if the country produce OA amount of
Capital goods the opportunity cost is OB amount of consumer
goods. The next best alternative forgone to produce OA amount of Capital
goods is OB amount of consumer goods. If the country reduces its production
from OA to OP amount of Capital goods, then the opportunity cost is also
reduced from OB to OQ amount of consumer goods.
Production
possibility curve below shows the inefficient attainable
and unattainable combinations
of production. The combination of production beyond the curve is
unattainable as shown as point Y and combination of the point below the curve is
an inefficient combination as shown as point X . Different combinations of production possibilities are on
the production possibility curve.
The concave production possibilities curve shows decreasing opportunity cost. In this case, opportunity cost actually decreases with greater production as shown above. In this case the economy forgoes decreasing amounts of one good when producing more of the other.
The production possibilities schedule is illustrated
graphically through the slope of the production possibilities curve. A
production possibilities curve or frontier is used in production economics to
indicate how much of each good or service a firm can opt to produce given that
it has limited resources which it has to efficiently allocate between
production of 2 goods.
The slope or shape of the production–possibility
frontier (PPF) at any given point is called the marginal rate of transformation (MRT). The slope defines the rate at which production of one good
can be redirected (by re-allocation of production resources) into production of
the other. It measures how much of good Y is given up for one more unit of good
X or vice versa.
Normally it generates a distinctive convex shape, flat
at the top and steep at the bottom. The convex
production possibilities curve shows an increasing
opportunity cost. In this case the economy forgoes increasing amounts of
one good when producing more of the other.
The straight line production possibilities
curve that indicates constant
opportunity cost. In this case, opportunity cost does not change with
production. Here the economy forgoes the same amount of one good when producing
more of the other.
Evaluation of a particular situation with
Opportunity cost Analysis is
possible only if a person or a firm or a government confront with a situation
with many choices.
A person’s daily life is all about choices;
The following situations explained using diagrams
shows the application of Opportunity cost curve (i.e. Production
Possibility Curve).
In
our daily life there are
many things which illustrate the concept of opportunity cost.
For
example,
(a) staying in tonight to complete homework OR going out for the evening;
(b) saving money for the future OR buying an expensive consumer good.
(a) staying in tonight to complete homework OR going out for the evening;
(b) saving money for the future OR buying an expensive consumer good.
Other examples are;
Whether saving money for the
future OR buying an expensive diamond jewellery;
Whether to get up on time when the alarm goes
off OR to sleep a little longer;
Whether to drive to work OR catch public transport;
Whether to have a healthy breakfast at home OR grab a Mc Burger on the way to work.
Whether to have a healthy breakfast at home OR grab a Mc Burger on the way to work.
Of course, all these choices involve implications in
terms of opportunity cost.
There
are many other things in our
country, which apply the concept of opportunity cost in
terms of decisions made by governments, such as
building a school OR buying armaments [ war weapons].
There are many other things with national importance, which apply
the concept of opportunity cost in terms of decisions made by
governments, such as building a school OR buying
armaments [ war weapons]. A good contemporary example in the global economy
might be the expenditure of the government on a
military research project when it is still receiving aid from
different countries around the world to help its people. The implications of a
particular course of action can also be explained using a Opportunity
cost curve OR Production Possibility Curve (PPC)
A
good contemporary example in the global
economy might be the expenditure of the Chinese government on a
space project when it is still receiving aid from different countries around
the world to help its people.
The
following situations are explained using diagrams, shows the application of
Opportunity cost.
Increase in capacity of production : A rightward shift of
curve shows an increase in capacity of production either due
to a)
increase in labour force OR b) increase in the stock of
capital OR c)
increase in technology.
Decline in productivity : A
leftward shift of curve shows a decline in productivity
either due to a) War OR b) natural disaster
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