Opportunity Cost

 

The cost of shifting resources from use A to use B is called opportunity cost.

Example -

 

Assume that you have 10 hectares of land, you can produce apple and wheat on your land -

 

Apples [kg]	100	90	70	40	0
Wheat [kg]	0	25	50	75	87

 

Using all your given resources you can produce either 100 lakh kg of apple or 87 lakh kg of wheat. And if you wish to produce both apples and wheat you can select any combination of two goods from the table.

 

1. So first you decide to produce 100 kg of apples, so you have prepared your land for better production of apples and bought machinery for apple production.

2. But after some years you decide to produce wheat in some parts of your land, so you have to shift your resource from apple to wheat. Now you produce 90kg of apple and 25kg of wheat.

3. After some years you decide to increase your wheat production [ due to more profits by selling wheat ], so you shift some more resources from apple to wheat. Now you produce 70kg of apple and 50kg of wheat.

 

Therefore -

 

1. When you produce 25 kg of wheat, you have to reduce your apple production to 90 kg [ which is a reduction by 10 kg of apple]

 

So your cost of producing 25 kg of wheat is 10 kg of apple.

 

Opportunity cost = 10 kg of apple  

 

2. When you produce 50 kg of wheat, you have to reduce your apple production to 70 kg [ which is a reduction by 20 kg of apple]

 

So your cost of producing 50 kg of wheat is 20 kg of apple. 

 

Opportunity cost = 20 kg of apple 

 

3. And for producing 75 kg of wheat, you have to reduce your apple production to 40 kg             [ which is a reduction by 30 kg of apple]

 

So your cost of producing 75 kg of wheat is 30kg of apple.  

 

Opportunity cost = 30 kg of apple 

 

Important points -

 

1. Opportunity cost tends to rise as you shift more and more resources from apple to wheat.

2. The opportunity cost rises because the resources you earlier had for the production of apple is not equally sufficient for the production of wheat.

3. Total opportunity cost refers to the total loss of output when the given resources are shifted from use 1 [apple] to use 2 [wheat]

4. Marginal opportunity cost refers to opportunity cost per unit of additional output of use 2 when some resources are shifted from use 1 to use 2

MOC = Total loss of output of crop 1 / Total loss of output of crop 2

 

Apple [kg]	Wheat [kg]	Marginal opportunity cost
100	0	-
90	25	10/25 = 0.4
70	50	20/25 = 0.8
40	75	30/25 = 1.2
0	87	40/12 = 3.33

 

 Thank You 

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