opportunity cost

• Opportunity cost


  The value of the next best alternative forgone
• Trade-off


  When one thing is lost to gain something else
• Trade-off example


  • Choosing between buying a chocolate bar or a packet of crisps with £1
• If a car is bought for £15,000 and after 5 years the value depreciates by £5,000, the opportunity cost of keeping the car is £5,000
• Opportunity cost


  • Important to economic agents such as consumers, producers and governments
  • Producers might have to choose between hiring extra staff and investing in a new machine
  • Government might have to choose between spending more on the NHS and spending more on education
• Production Possibility Frontier (PPF)


  Depicts the maximum productive potential of an economy, using a combination of two goods or services, when resources are fully and efficiently employed
• Points A and B on the PPF are the most productively efficient points, because resources are being used to their full productive potential
• The law of diminishing returns states that the opportunity cost of producing more yoghurt increases, in terms of the lost units of cheese that could have been produced
• Producing at C or D on the PPF is inefficient, and resources are not used to their full productive potential
• Producing 100 units of cheese means that only 40 units of yoghurt can be produced instead of the potential of 90, so the opportunity cost is 90 - 40 = 50 units of yoghurt
• Economic growth


  Shown by an outward shift in the PPF
• Economic decline


  Shown by an inward shift in the PPF
• The original PPF curve is drawn assuming a fixed amount of resources and a constant state of technology
• An increase in the quantity or quality of resources shifts the PPF curve outwards, so the productive potential of the economy increases, and there is economic growth
• Moving along the PPF uses the same number and state of resources, and shifts production from fewer consumer goods to more capital goods, incurring an opportunity cost
• Shifting the PPF curve outwards uses either more resources or resources of a greater quality, reducing the opportunity cost of producing either capital or consumer goods
• Capital goods


  Goods which can be used to produce other goods, such as machinery
• Consumer goods


  Goods which cannot be used to produce other goods, such as clothing
• Some alternatives are not easy to quantify, such as spending a year travelling or a year gaining work experience
• Opportunity costs relate to future events, so they are difficult to place a monetary value on
• Many firms operate on predetermined targets which overlook opportunity cost
• Opportunity costs always exist because of scarce resources, so they are often overlooked in reality