Question

Use the concept of opportunity cost to show how one might legitimately object to saving more in order to increase economic growth.

Answer 1

Opportunity cost refers to value of a factor in its next best alternative use.

The Production Possibilities Curve (PPC) is a model used to show the tradeoffs associated with allocating resources between the production of two goods. The PPC can be used to illustrate the concepts of scarcity, opportunity cost, efficiency, inefficiency, economic growth, and contractions.

Let us assume that a given set of resources have two uses : Use 1 and Use 2. If value of output in Use 1 is Rs 400 and the value of output in Use 2 is Rs 500 (technique of production remaining constant), common sense shoud dictate us that the resources will be employed in Use 2. Given this situation, opportunity cost may be defined as loss of output in Use 1 (= Rs 400) when resources are employed not in Use 1 but in Use 2. In other words, opportunity cost refers to value of a factor in its next best (or second best) alternative use.

Marginal Opportunity Cost : Total resources constant, when (using the given technology) allocation in Use 2 is increased, there is a loss of output in Use 1 (Change in Quantity 1) and gain of output in Use -2 (Change in Quantity 2). The rate at which output in Use 1 is lost for every additional unit of output in Use 2 (Change in Quantity 1 /Change in Quantity 2) implies marginal opportunity cost.

Marginal Opportunity Cost = Change in Quantity 2 / Change in Quantity 1

Marginal Opportunity Cost = change in loss of output / change in gain of output

Constant opportunity cost : when the opportunity cost of a good remains constant as output of the good increases, which is represented as a PPC curve that is a straight line.

Increasing opportunity cost : when the opportunity cost of a good increases as output of the good increases, which is represented in a graph as a PPC that is bowed out from the origin.

Production possibilities curve (PPC) : (also called a production possibilities frontier) a graphical model that represents all of the different combinations of two goods that can be produced; the PPC captures scarcity of resources and opportunity costs.

To find the opportunity cost of any good X in terms of the units of Y given up, we use the following formula:

Opportunity cost of each unit of good X= (Y1​−Y2​) ÷ (X1​−X2​) units of good Y