The Problem of Opportunity Cost - Essay Example

Opportunity cost The problem of opportunity cost and how it relates to the problem of choice between scarce resources. The basic problem of Economics is the allocation of the scarce resources among the various unlimited needs of the human beings. These resources have competing uses and it is the task of the economic agents to make the allocation of the scare resources among the different uses. The agents make various choices of these resources and for each and every choice that is made there are a large number of options to choose from. For example by choosing to go for music DVD giving up a Film DVD then the benefit that would be derived by watching the film would be the opportunity cost for buying the music DVD apart from a specific economic cost. The word cost in the context of economic production is defined as the opportunity cost of producing any good or service. It is considered to be the value that the factors of production or the resources could have generated if they were utilized for the next best use. In other words the opportunity cost is the sacrifice of the next best alternative that is made by consumption or production of a good or service. Thus when the resources are limited an individual has to make choices between the different alternatives. Accordingly by choosing one alternative he gives up the opportunity for enjoying the other remaining alternatives that he has not opted for. This is known as the opportunity cost of consumption or production. Hence it is the most important element in the context of economic that helps in the determination of the choice between the scare resource and the efficient allocation of the resources. Hence the opportunity cost is not only the money value that is given up for one particular choice but also the time costs and the psychological costs that are paid for the non-consumption of a product or service. This can be explained with the following example. A person having $10 may decide either to buy a book or an ice cream. If the person buys a book he would have to give up his opportunity to buy the ice cream and enjoy it. On the other hand if he buys an ice cream he gives up the opportunity to read the book. In both the cases the person has to pay an opportunity cost for choosing one option over the other (Samuelson 17). The concept of opportunity cost is used mostly in the context of production decisions. The main factors of production include capital and labor. Suppose a person works in a factory and he earns $10 per day. On the other hand he could have worked in his own farm and could have earned $ 7 a day and could have enjoyed labor for a longer time. Therefore by earning $3 extra per day by working in the factory the person is sacrificing his leisure during the day and this is the opportunity cost incurred for earning the extra $3. Therefore the economic cost of production of the worker should also incorporate the economic cost of production for the person. Similarly a person can set up a shoe factory that would produce 1000 shoes per week. Alternatively he can set up a chocolate factory that would produce 500 boxes of chocolates per day. If the person sets up the shoe factory he is paying the opportunity cost of not setting up the chocolate factory. Thus the capital as a factor of production also has alternative uses and the producers would give up the various opportunities or options for pursuing one single option. This prospect of giving up the opportunities arise from the fact that the resources are limited and therefore in order to make the most out of the endowments individuals choose the best of the available alternatives leaving out the opportunity for the next best and the next to next best and so on. The theory of the allocation of the resources and the opportunity cost can be explained with the help of the following production possibility frontier diagram. The production possibility frontier is the curve which depicts the various combinations of the goods that the economy can produce in a situation in which all the productive resources are exhausted in the efficient manner. In the following PPF it is a two good economy that produces wheat and sheep only. At the point E on the PPF, the economy produces B units of sheep and 1 unit of Wheat. On the other hand at the point F the economy produces one unit of Sheep and 2 units of wheat. At the point C the economy produces only sheep and no wheat. Similarly at the point 3 the economy produces only wheat and no sheep. These two are the special cases of corner allocations. The principle of opportunity cost is clearly explained with this. Figure 1: Production Possibility Frontier Source: Anderton 5 Suppose the economy produces at the point E and has an intension to move to the point F. As a result the output of wheat will increase to 2 from 1 unit. But the opportunity cost would be the loss of the output of sheep by AB units which would now reduce from B to A. Hence the opportunity cost for production at the point F would be the loss in the sheep production by AB units. Thus the diagram provides an idea about the possible combination of the goods that can be produced by the maximization of the outputs for a fixed amount of resources that is given. Therefore it is clear that an individual should analyze the various alternatives from the point of view of opportunity cost while deciding how the goods can be allocated efficiently. Since the resources are limited, the firms should make the right decision of what to be produced that would satisfy the needs or the demands of the consumers. Hence the three important nuances of economics that is the proper allocation of resources, achievement of efficiency and full employment and the maintenance of economic growth can all be explained with the help of opportunity cost. Works cited Anderton, Alain. Economics: A Level Student Book. London: Pearson Education. 2009. Print. Samuelson, Paul Anthony and ‎ William D. Nordhaus. Economics. New Delhi: Tata McGraw-Hill Education. 2010. Print. Read More