Principles of Macroeconomics / Unit 1 MAC 0030 review, 2 to 3 minutes
Where Opportunity Cost Keeps Turning Up
The idea
Opportunity cost is the one idea this unit keeps returning to, and it arrives in three different diagrams that are really the same idea drawn three ways. In the budget constraint it is a price ratio: with income fixed, buying one more of a good means giving up some number of the other, and that number is the slope of the line. In the production possibilities frontier it is a resource ratio: a society moving resources into one good gives up units of the other, and that number is the slope of the curve. In comparative advantage it is the basis of trade: whichever producer gives up less to make a good should make it, and the two can then both end up with more than either could produce alone. The three are connected. The budget constraint is straight because prices do not change with the quantity bought. The frontier bows because resources are not equally suited to every use, so the opportunity cost rises as more is produced. And comparative advantage is a comparison of two producers' opportunity costs, which is why a country that is worse at making everything still has something worth specializing in.
In practice
Worked example: one student, one afternoon, three uses. Four hours of study would raise a grade; four hours at a job would earn sixty dollars; four hours of rest would restore energy for the week. The opportunity cost of studying is not all three of the others, but the single best one given up, whichever the student would otherwise have chosen. If the job is the next best use, the cost of studying is sixty dollars. If rest is, the cost is the rest. The same structure scales up. For a society the afternoon is its resources, the uses are the goods it could produce, and the frontier draws the same tradeoff for millions of people at once.
Where people slip
Three cautions carry forward. Opportunity cost counts the next best alternative only, not the sum of everything forgone, so a choice among five options has one opportunity cost and not four. It is measured in what is given up, which may be goods, time or output, and often not in money, so the receipt is an incomplete record of what a choice cost. And it looks forward: what has already been spent is a sunk cost and belongs to no decision still to be made. Every later unit uses this. The cost of holding money is the interest forgone, the cost of government borrowing is the private investment not made, and the cost of protecting an industry is the industries that pay more for its output.
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