Making economic desicions

• Opportunity cost


  The value a person could have received but passed up in pursuit of another option
• When Bob chooses to gather 1 banana, he gives up

  1 fish
• Bob trades with himself by

  Gathering bananas or catching fish
• Opportunity cost examples


  • Waiting in line for free ice cream gives up the opportunity to do something else with your time, like working at a job or reading a book
• When Ann chooses to gather 1 banana, she gives up

  3 fish
• Ann trades with herself by

  Gathering bananas or catching fish
• Economists use the concept of opportunity cost to determine


  If people can benefit from trading with one another
• Resources in the example economy

  • 10 laborers
  • 5 machines
• Introduction of the production possibility frontier

  1. Graph representing different choices that can be made based on available resources

  2. Key to understanding production decisions made by the economy to solve the economic problem
• Production possibility frontier

  Graph showing available or possible choices for what can be produced based on resources
• Graphing production possibilities

  Make a graph with the amount produced of one good on the vertical axis and the other on the horizontal axis, then draw in the combinations
• Possible production choices in the example economy

  • 100 lots of popcorn and no movies
  • 50 movies and no popcorn
• Combinations of popcorn and movies in the example economy

  • Impossible mixtures:
  • 10 popcorn and 10 movies
  • 60 popcorn and 20 movies
  • 40 popcorn and 30 movies
  • 20 popcorn and 40 movies
• To make ten extra movies

  The economy has to sacrifice twenty boxes of popcorn since resources used for popcorn need to be redirected to making movies
• People may prefer a combination like 80 popcorn and 10 movies to satisfy their wants
• Society chooses the most desirable combination of popcorn and movies based on available resources
• Goods in the example economy

  • Movies
  • Popcorn
• Graphing production possibilities

  Make a graph with the amount produced of one good on the vertical axis and the other on the horizontal axis. Draw in the combinations to represent different choices
• Points beyond the possibility frontier

  • Represent unattainable points due to limited resources
• The PPF shows what amounts of goods can be made when all inputs are being used
• Points inside the PPF

  • Represent unemployment where resources are not being used to their full extent
• Point on the line


  • Represents a particular combination of goods where the economy's resources are fully utilized
• Point inside the production possibility frontier

  • Represents an inefficient allocation of resources where less is being produced than possible with full resource utilization
• The PPF is a great way to visualize the choices about production made by every economy
• The PPF is a graphical representation of available combinations of production limited by the resources available
• Next time, we'll look at the slope of the PPF and how it can represent opportunity cost
• Points on the PPF

  • Considered optimal because the economy is making as much as possible with its resources and satisfying as many wants as possible
• Point beyond the production possibility frontier


  • Represents a choice where the economy is trying to reach a point outside its resource constraints
• Determining the value of benefits and costs in a cost-benefit analysis is challenging
• Option 4: Benefits $240,000, Costs $300,000, Net loss $60,000
• Analysis conducted by the government

  1. Considering options with associated benefits and costs

  2. Calculating net benefit or net cost to select the project with the highest net benefit
• Example of a cost-benefit analysis scenario


  • Deciding whether to introduce traffic lights at an intersection
• Option 3: Benefits $230,000, Costs $220,000, Net benefit $10,000
• Caution in selecting the option with the greatest benefit due to the importance of data quality in a cost-benefit analysis
• Option 1: Benefits $120,000, Costs $180,000, Net loss $60,000
• Cost-benefit analysis

  1. Explaining how to conduct a cost-benefit analysis

  2. Analysing the limitations of a cost-benefit analysis
• Challenges in placing a monetary value on an individual's life or wellbeing in a cost-benefit analysis
• Difficulty in determining the value of a project when people don't pay to use it
• Estimating costs of materials and services for a project is easier than estimating benefits accurately
• Government undertaking a cost-benefit analysis for public investment projects

  To assess the value of the project and decide whether to progress with it