Warren Norred

How Is The Law Of Supply Related To Opportunity Cost?

• Marvin Harvey
• 21.12.2022
• 0
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When consumers experience higher opportunity costs, then they will shift to consuming substitutes. The law of supply indicates that keeping the other factors fixed, movements in price positively affect the movements in quantity supplied.

How is opportunity cost related to supply curve?

Supply Terminology When a firm supplies a good or service, then you assume 3 things:

The firm has the resource and technology to produce it. The firm profits from making it. The firm is definitely making it and selling it

The quantity supplied of a good or service is the amount that producers plan to make and sell during a time period at a specific price. Law of Supply and Supply Curve Law of Supply: the higher the price of a good, the bigger the quantity supplied. This also happens vice versa. The supply curve function is Q s Q_ = a + bP, where

P is the price of the good or service Q s Q_ is the number of quantity supplied

Note: The supply curve is the same as the marginal cost curve we’ve seen last chapter. Two reasons why the curve is upward sloping:

Increasing Opportunity Cost: The higher the price, more firms are willing to produce and sell because any higher opportunity costs can be covered by the higher price. Thus, more products are supplied. Rising Marginal Cost: the more units are produced, the higher the marginal cost of production. So firms need to make sure that the extra addition unit cost is covered by the higher price in order to make profit.

Change in Supply The supply curve can either shift rightward or leftward. Reasons why supply curves can shift:

Prices of Factors of Production: if the prices for factors of production increases, then it becomes more costly, causing producers to produce less of the supply at the price. This shifts the supply curve to the left. Prices of Related goods produced: prices of related goods which firms make influence supply.

Substitutes: Suppose good x and y are substitutes. If the firm is producing good x, and the price of good y increases, then the firm switches to good y, causing the supply of good x to decrease. Complements: Suppose good x and y are complements. Then increasing the price of good x will increase the supply of good y.

Expected future prices: If the price of a good is expected to rise in the future, then the supply of the good today decreases. This causes the supply curve to shift leftward. Number of Suppliers: The more supplies there are, the greater the supply of the good. This increases the number of supplies, which shifts the supply curve right. Technology: Advancement in technology lowers the cost of producing, which means suppliers will produce more of the product. This shifts the supply curve to the right. State of Nature: Any natural disaster that can influence the production, or damage the supply will lower the amount of supply. This decreases the amount of supply, which shifts the supply curve leftward.

How opportunity cost is related to?

Opportunity cost is an economics term that refers to the value of what you have to give up in order to choose something else. In a nutshell, it’s a value of the road not taken.

How is opportunity cost related to the supply of goods and services?

Lesson 1: Opportunity Cost – Foundation For Teaching Economics

• Opportunity Cost
• Scarcity
• Capital Goods
• Choice
• Consumer Goods
• Communism

Standard 1: Productive resources are limited. Therefore, people cannot have all the goods and services they want; as a result, they must choose some things and give up others. Benchmarks:

• Whenever a choice is made, something is given up.
• The opportunity cost of a choice is the value of the best alternative given up.
• Scarcity is the condition of not being able to have all of the goods and services one wants. It exists because human wants for goods and services exceed the quantity of goods and services that can be produced using all available resources.
• Like individuals, governments and societies experience scarcity because human wants exceed what can be made from all available resources.
• Choices involve trading off the expected value of one opportunity against the expected value of its best alternative.
• The evaluation of choices and opportunity costs is subjective; such evaluations differ across individuals and societies.
• Choices made by individuals, firms, or government officials often have long-run unintended consequences that can partially or entirely offset the initial effects of their decisions.

Standard 3: Different methods can be used to allocate goods and services. People, acting individually or collectively through government, must choose which methods to use to allocate different kinds of goods and services. Benchmarks:

• No method of distributing goods and services can satisfy all wants.
• There are different ways to distribute goods and services (by prices, command, majority rule, contests, force, first-come-first-served, sharing equally, lottery, personal characteristics, and others), and there are advantages and disadvantages to each.
• Scarcity requires the use of some distribution method, whether the method is selected explicitly or not.
• There are essential differences between a market economy, in which allocations result from individuals making decisions as buyers and sellers, and a command economy in which resources are allocated according to central authority.
• People in all economies must answer three basic questions: What goods and services will be produced? How will these goods and services be produced? Who will consume them?
• National economies vary in the extent to which they rely on government directives (central planning) and signals from private markets to allocate scarce goods, services, and productive resources.
• Comparing the benefits and costs of different allocation methods in order to choose the method that is most appropriate for some specific problem can result in more effective allocations and a more effective overall allocation system.

Standard 15: Investment in factories, machinery, new technology, and the health, education, and training of people can raise future standards of living. Benchmarks:

• Economic growth is a sustained rise in a nation’s production of goods and services. It results from investments in human and physical capital, research and development, technological change, and improved institutional arrangements and incentives.
• Historically, economic growth has been the primary vehicle for alleviating poverty and raising standards of living.
• Economic growth creates new employment and profit opportunities in some industries, but growth reduces opportunities in others.
• Investments in physical and human capital can increase productivity, but such investments entail opportunity costs and economic risks.
• Investing in new physical or human capital involves a trade-off of lower current consumption in anticipation of greater future production and consumption.
• The rate of productivity increase in an economy is strongly affected by the incentives that reward successful innovation and investments (in research and development, and in physical and human capital).

How does opportunity cost affect supply and demand?

Key Ideas – Download lesson full for procedures and teaching tips.1. Review:

Scarcity forces us to make choices. People (not governments, nations, or societies) choose.

2. Every choice has an opportunity cost. The opportunity cost of choosing an alternative is the value of the “next-best” foregone alternative.

Relate opportunity cost to the choices students made in the “The Magic of Markets” trading game.

3. Because people make choices, all opportunity costs have the following characteristics:

All costs are costs to someone. Only people bear costs. Costs are subjective. Individuals may value costs differently. Opportunity costs result from actions. “Things” have no costs in and of themselves. All costs relevant to decision making lie in the future. People can anticipate costs, but they occur only after a choice has been made.

4. Incentives are the rewards or punishments that shape people’s choices.

Incentives can be either monetary or non-monetary. When opportunity costs change, incentives change, and people’s choices and behavior change. Changes in incentives cause people to change their behavior in predictable ways.

5. Price acts as an incentive to consumers and producers.

Higher (lower) prices require consumers to give up more (fewer) resources to obtain goods. Consumers react to changing price incentives by altering their consumption choices or the quantity demanded of goods. The Law of Demand predicts an inverse or negative relationship between quantity demanded and the price of a good. Prices affect producers of goods by offering them greater benefits from production when prices increase or lower benefits when prices decrease. The Law of Supply predicts a positive relationship between quantity supplied and the price of a good.

6. All costs or benefits that affect decisions are marginal costs or marginal benefits.

As long as the marginal benefit of an activity exceeds the marginal cost, people are better off doing more of it. When the marginal cost exceeds the marginal benefit, they are better off doing less of it. Past costs are called “sunk” costs. The sunk cost fallacy occurs when people fail to recognize that the relevant costs and benefits occur at the margin, which necessarily involves future costs and benefits. Marginal analysis helps people to make more informed decisions.

Those who do not use marginal analysis are likely to reduce the total benefits available from the choices made.

In the whole economy, a lack of marginal decision making reduces income and growth.

7. Because of scarcity, all goods and services must be rationed. The question is: How are they rationed?

Economies must use rationing mechanisms to determine what is produced, how it’s produced, and who gets what is produced. People’s choices are influenced by the incentives incorporated in rationing mechanisms. The rationing mechanism may encourage or discourage economic growth. Rationing by money price has proven effective in addressing the allocation problem presented by scarcity, and in providing information that encourages economic growth. Changes in price create incentives for predictable changes in people’s behavior that reduce the impact of scarcity.

A higher money price encourages more production (or a greater quantity supplied), while at the same time requiring buyers to give up more resources. When buyers face higher opportunity costs to acquire a particular good or service, they react by seeking less costly substitutes; thereby reducing quantity demanded. As production increases and quantity demanded decreases, quantities that people are willing to exchange come into balance. Thus, a changing money price causes the marketplace to reach equilibrium between quantity supplied and quantity demanded.

While we employ a variety of rationing mechanisms in the American economy, the advantages of money-price rationing mean that most goods and services are rationed in this way.

How is the law of supply related to opportunity cost quizlet?

A lower price means the opportunity cost of not supplying the good rises. The law of supply rests upon the ability of suppliers to substitute toward the production of goods whose prices have not declined. A lower price means a lower opportunity cost of not supplying the good.

What is opportunity cost in supply?

Introduction – Opportunity cost refers to what you have to give up to buy what you want in terms of other goods or services. When economists use the word “cost,” we usually mean opportunity cost.

The word “cost” is commonly used in daily speech or in the news. For example, “cost” may refer to many possible ways of evaluating the costs of buying something or using a service. Friends or newscasters often say “It cost me $150 to buy the iPhone I wanted.”

Which is most closely associated with opportunity cost?

Resource scarcity. Opportunity cost refers to forgone decisions. Resource scarcity refers to limited resources.

What is the importance of opportunity cost in our economy?

Opportunity Cost Dr. Aleksandar (Sasha) Tomic If You Don’t Know What It Is, You Might Regret It Advertising & Editorial Disclosure Last Updated: 12/9/2022 Dr. Aleksandar (Sasha) Tomic Have you ever faced an opportunity or choice and said to yourself, “If I don’t do this, I’ll regret it”? In a situation where you are deciding amongst several options, there’s always a benefit you miss out on that’s associated with the choice(s) you don’t take.

This foregone benefit can be thought of as a cost to you related to making your decision and, in the field of Economics, it’s referred to as an opportunity cost. The simple definition of opportunity cost is: Opportunity Cost is the benefit foregone related to the alternative choice when a decision is made.

In other words, an opportunity cost is the regret you anticipate from not taking another option. For example, if you spend your time studying for an exam, the opportunity cost would be the time you could have spent having fun. This concept acknowledges not just the explicit costs of a choice but also the implicit costs of what you forgo when you make that decision.

Opportunity cost provides a framework for decision-making to find the most benefit, particularly for limited resources like time and money. Within the context of, opportunity costs are the expected return on the investments you are evaluating. A simple example of opportunity cost in investing is in the bond markets.

If you purchase bonds and hold them to maturity, they will provide a rate of return as stated. Pretend you have a bond that pays 5% and another that pays 2%, and you have $1,000 to invest. The expected return is $50 and $20, respectively. In this simple example, we can see that, all else equal, the bond paying $50 is the better choice. Where FO is the return or value of the forgone option, and CO is the return or value of the chosen option The return on an option is signified as the benefit minus the explicit costs of that option. In the example above, the returns are $50 and $20. For a business, the return would be the profit it makes from selling its products.

• No – Opportunity Cost is negative.
• Yes – Opportunity cost is positive.

The -$30 and $30 are the opportunity costs of buying the other investment. That is, if you went with the 2% rate of return over the 5%, your “cost” or regret would be $30. In the instance where you select the 5% return investment, your “cost” is a negative $30, indicating you would not regret the decision. There are a couple of challenges to calculating opportunity costs. One challenge is that different people can value the same choices differently. In other words, they are subjective to individuals and situations. Another challenge is that in evaluating a decision, we may end up miscalculating the benefits. MONEYGEEK EXPERT TIP Opportunity costs for the same choices can differ for different people and in different situations. Opportunity costs can be more difficult to assign numbers to when you’re talking about an example like leisure time. Let’s say your employer calls and offers you an extra hour of work at your job.

• Running an important errand
• Spending time with loved ones
• Sleeping
• Avoiding a long commute time

Thankfully, our brains are able to tell us what we value at the moment as it relates to our day-to-day lives. In the last example, where you have an opportunity to earn an extra hour’s worth of pay, we’ll often neglect to consider the future value of our opportunities.

If we work that extra hour and then invest those earnings in the future, it can grow to be worth much more. There are many examples of the “skip the latte” argument in personal finance. Say you have a $5 latte every day instead of saving that $5. Over 20 years, you’re not just missing out on the $36,500 you could have saved (365 days x $5 x 20 years).

You’re missing out on $61,655, which is the $36,500 you spent plus the investment returns you could have earned from compounding your savings for 20 years with a 5% annual investment return. Have you ever said or heard someone say, “I/we have already spent” to justify why a choice is made? Maybe you’ve heard a story of someone going to an outdoor concert to see an act they weren’t that into in the pouring rain just because they had bought the ticket? Or a company continuing to spend money on a failing project because it had already spent a considerable amount on it? At some point, these people had a chance to reassess their situation and potentially back out, despite the costs they had already incurred.

• These already incurred costs are referred to as sunk costs, and they are costs you can’t recover regardless of what you do.
• Opportunity costs are strictly forward-looking and ignore costs you can’t recover because they do not represent your benefit.
• Say that a company has spent $5 million and two years implementing a new software system.

They have one more year of work left and another $2.5 million to spend to complete the system. A new technology has come to the market that provides the same benefits. The new technology will take six months to implement and cost $2 million. In this example, the benefit is the same, so the opportunity costs are just the costs: one year for $2.5 million or six months for $2 million. MONEYGEEK EXPERT TIP The sunk cost fallacy is sticking to a course of action when other options have a higher return/benefit. Because opportunity costs are forward-looking, to the extent that it’s possible, they should include measures of uncertainty.

1. When asked to explain opportunity costs, what is your go-to example?
2. Can you provide a few examples of how individuals weigh opportunity costs every day?
3. What are the drawbacks or challenges to weighing the opportunity cost when making decisions?
4. Are there decision-making strategies individuals or organizations can use when the opportunity cost of a decision isn’t clear-cut?
5. What’s a good way for individuals to think about the opportunity costs associated with saving money or spending it today?

Zachary Schaller Assistant Professor of Economics at Colorado State University Samia Islam, Ph.D. Graduate Program Coordinator, Professor, Department of Economics at Boise State University Don Uy-Barreta Professor Scott Deacle Associate Professor of Business and Economics and Department Chair at Ursinus College Dr. Derek Stimel Associate Professor of Teaching Economics at University of California, Davis Peter Zaleski Professor of Economics at Villanova University Danny Ervin Professor of Economics and Finance at Salisbury University Linda M.

Hooks Professor of Economics and Head of the Economics Department at Washington and Lee University Benjamin Shiller Assistant Professor of Economics at Brandeis University Brian Jenkins Associate Teaching Professor and Director of Undergraduate Studies in the Department of Economics at the University of California, Irvine Wendy Habegger Lecturer at James M.

Hull College of Business at Augusta University Dr. Leo Chan Associate Professor of Finance Economics at Utah Valley University Dr. Aleksandar (Sasha) Tomic Economist and Program Director of Boston College’s MS in Applied Economics Program, Associate Dean, Strategy, Innovation, & Technology, Woods College of Advancing Studies, Boston College Sahar Bahmani Professor of Finance at the University of Wisconsin, Parkside Matthews Barnett, CFP®, ChFC®, CLU® Financial Planning Specialist at Wiser Wealth Management, Inc.

Josh Stillwagon Associate Professor of Economics at Babson College Jorgen Harris Assistant Professor of Economics at Occidental College Bruce Sacerdote Richard S. Braddock 1963 Professor in Economics at Dartmouth College David Kuenzel Associate Professor of Economics at Wesleyan University Evan W. Osborne, Ph.D.

Professor at Wright State University John Korsak Assistant Teaching Professor, University of Massachusetts Lowell, Economics Department Dr. Michael Snipes Associate Professor of Instruction at University of South Florida Vicar Valencia Indiana University South Bend Dr.

Brandon Di Paolo Harrison Assistant Professor of Accounting at Austin Peay State University Nicolas Jankuhn Assistant Professor of Marketing at the University of Southern Indiana Jared Watson Assistant Professor of Marketing at New York University Stern School of Business Matt Rutledge Associate Professor of the Practice of Economics and Research Fellow at the Center for Retirement Research at Boston College Tonya Williams Bradford Associate Professor at UCI Paul Merage School of Business, University of California Opportunity cost is the difference in the benefit of a choice you are forgoing compared to the benefit of the choice you are making.

You’ll recognize opportunity cost as an estimation of how much regret you’ll feel for making one choice over another. Opportunity costs are real in the sense that there is always a missed opportunity when you’re allocating resources (time, money, etc.).

1. Economists may refer to opportunity costs as the real costs.
2. However, it’s important to note that opportunity costs will not be reflected in a bank account or a company’s income statement because they only reflect the choices made, not the choices that are not taken.
3. A is choosing between two investment options with a guaranteed return.

Suppose they both require the same amount of investment, but one will pay you $50, and the other will pay you $20. The opportunity cost is -$30 for the $50 return, indicating there isn’t a cost but rather a net benefit. The opportunity cost for the $20 return is $30, indicating that choosing the $20 return option would mean you’re missing out on a higher potential benefit.

1. This is simple when the net benefit or return is known.
2. But determining the net returns of options,
3. For example, how do you choose between an extra hour of leisure time or an extra hour of paid work? Opportunity cost is a framework that helps us understand choices and can be used to help select the best choice in how to use a scarce resource (time, money, etc.).

It’s a powerful concept that is the basis for several other economics and behavioral economics concepts, such as comparative advantage. In business and investing contexts, opportunity costs are analyzed in a variety of decisions, such as which products to create and portfolio allocation.

Yes. The for calculating opportunity cost is to compare the net benefit of one choice with the benefit of another option. If the difference between those benefits is zero, then the opportunity cost is zero, meaning you’d get the same benefit from either choice. About the Author Doug Milnes is the head of marketing and communications at MoneyGeek.

He has spent more than a decade in corporate finance performing valuations for Duff and Phelps and financial planning and analysis for various companies including OpenTable. He holds a master’s degree in Predictive Analytics (Data Science) from Northwestern University and is a CFA charter holder.

What is opportunity cost and why is it important?

What Is Opportunity Cost? – Opportunity costs represent the potential benefits that an individual, investor, or business misses out on when choosing one alternative over another. Because opportunity costs are unseen by definition, they can be easily overlooked.

What is meant by the law of supply?

What Is the Law of Supply? – The law of supply is the microeconomic law that states that, all other factors being equal, as the price of a good or service increases, the quantity of goods or services that suppliers offer will increase, and vice versa.

What causes increase in opportunity cost?

Transcript: – Below is the full transcript of this video presentation. It has not been edited for readability, and there may be slight differences between the text and the video. Our final lesson focuses on the shape of the frontier line. Up to this point we’ve graphed the PPF as a straight line.

However, a straight line doesn’t best reflect how the real economy uses resources to produce goods. For this reason, the frontier is usually drawn as a curved line that is concave to the origin. This curved line illustrates our fifth and final lesson. Lesson 5: The law of increasing opportunity cost: As you increase the production of one good, the opportunity cost to produce the additional good will increase.

First, remember that opportunity cost is the value of the next-best alternative when a decision is made; it’s what is given up. So let’s compare straight and curved frontier lines to better understand what is more likely to happen when production changes.

Here’s the straight frontier line again. It shows that Econ Isle can produce a maximum of 12 gadgets and 6 widgets or any other combination along the line. At this point, Econ Isle can produce 12 gadgets and 0 widgets. This point shows widget production increased by 2, and this by 2 more, and this by 2 more, indicating all widgets and no gadgets.

So along the straight line, each time Econ Isle increases widget production by 2, it loses the opportunity to produce 4 gadgets. This straight frontier line indicates a constant opportunity cost. In reality, however, opportunity cost doesn’t remain constant.

As the law says, as you increase the production of one good, the opportunity cost to produce the additional good increases. If Econ Isle transitions from widget production to gadget production, it must give up an increasing number of widgets to produce the same number of gadgets. In other words, the more gadgets Econ Isle decides to produce, the greater its opportunity cost in terms of widgets.

If Econ Isle’s production moved in the opposite direction, from all gadgets to all widgets, the law would still hold: As you increase the production of one good, the opportunity cost to produce the additional good increases. Why does this happen? Well, some resources are better suited for some tasks than others.

1. For example, many Econ Isle workers are likely very productive gadget makers.
2. In the transition to widget production, workers would likely need training and time to develop the skills required to be as productive at making widgets as making gadgets.
3. As the economy transitions from gadgets to widgets, the gadget workers best suited to widget production would transition first, then the workers less suited, and finally the workers not at all well suited to widget production.

Here’s where the curved frontier line comes in. It shows that opportunity cost varies along the frontier. Let’s increase widget production in increments of 2 again until only widgets and no gadgets are produced. But this time we’ll consider opportunity cost that varies along the frontier.

This point remains the same. At this point, Econ Isle can produce 12 units of gadgets and 0 widgets. Here’s widget production increased by 2. At this point, Econ Isle can produce 10 gadgets and 2 widgets. It loses the opportunity to produce 2 gadgets. In other words, the opportunity cost of producing 2 widgets is 2 gadgets.

Here’s widget production increased by another 2. At this point, if Econ Isle produces 6 gadgets, it can produce only 4 widgets, so it loses the opportunity to produce 4 gadgets. In other words, the opportunity cost of producing 2 widgets is now 4 gadgets.

1. Finally, increasing by another 2, Econ Isle can produce 0 gadgets and 6 widgets.
2. It loses the opportunity to produce 6 gadgets.
3. In other words, the opportunity cost of producing 2 widgets is now 6 gadgets.
4. Although the production possibilities frontier—the PPF—is a simple economic model, it’s a great tool for illustrating some very important economic lessons: The frontier line illustrates scarcity—because it shows the limits of how much can be produced with the given resources.

Any time you move from one point to another on the line, opportunity cost is revealed—that is, what you must give up to gain something else. Points within the frontier indicate resources that are underemployed. In turn, movement from a point of underemployment toward the frontier indicates economic expansion.

• When the frontier line itself moves, economic growth is under way.
• And finally, the curved line of the frontier illustrates the law of increasing opportunity cost meaning that an increase in the production of one good brings about increasing losses of the other good because resources are not suited for all tasks.

I hope you have enjoyed your journey to the frontier and learned some valuable lessons about economics along the way. – If you have difficulty accessing this content due to a disability, please contact us at 314-444-4662 or [email protected],

What is the relationship of law of supply?

The Law of Supply – The law of supply relates price changes for a product with the quantity supplied. In contrast with the law of demand the law of supply relationship is direct, not inverse. The higher the price, the higher the quantity supplied, Lower prices mean reduced supply, all else held equal.

What is the relationship between cost and supply?

Perfect competition – Economists have formulated models to explain various types of markets. The most fundamental is perfect competition, in which there are large numbers of identical suppliers and demanders of the same product, buyer and sellers can find one another at no cost, and no barriers prevent new suppliers from entering the market.

In perfect competition, no one has the ability to affect prices. Both sides take the market price as a given, and the market-clearing price is the one at which there is neither excess supply nor excess demand. Suppliers will keep producing as long as they can sell the good for a price that exceeds their cost of making one more (the marginal cost of production).

Buyers will go on purchasing as long as the satisfaction they derive from consuming is greater than the price they pay (the marginal utility of consumption). If prices rise, additional suppliers will be enticed to enter the market. Supply will increase until a market-clearing price is reached again.

If prices fall, suppliers who are unable to cover their costs will drop out. Economists generally lump together the quantities suppliers are willing to produce at each price into an equation called the supply curve, The higher the price, the more suppliers are likely to produce. Conversely, buyers tend to purchase more of a product the lower its price.

The equation that spells out the quantities consumers are willing to buy at each price is called the demand curve, Demand and supply curves can be charted on a graph (see chart), with prices on the vertical axis and quantities on the horizontal axis. Supply is generally considered to slope upward: as the price rises, suppliers are willing to produce more. Demand is generally considered to slope downward: at higher prices, consumers buy less.

The point at which the two curves intersect represents the market-clearing price—the price at which demand and supply are the same. Prices can change for many reasons (technology, consumer preference, weather conditions). The relationship between the supply and demand for a good (or service) and changes in price is called elasticity,

Goods that are inelastic are relatively insensitive to changes in price, whereas elastic goods are very responsive to price. A classic example of an inelastic good (at least in the short term) is energy. Consumers require energy to get to and from work and to heat their houses.

• It may be difficult or impossible in the short term for them to buy cars or houses that are more energy efficient.
• On the other hand, demand for many goods is very sensitive to price.
• Think steak.
• If the price of steak rises, consumers may quickly buy a cheaper cut of beef or switch to another meat.
• Steak is an elastic good.

Of course, most markets are imperfect; they are not composed of unlimited buyers and sellers of virtually identical items who have perfect knowledge. At the other end of the spectrum from perfect competition is monopoly, In a monopoly, there is one supplier of a good for which there is no simple substitute.

What is the law of opportunity cost?

The law of increasing opportunity cost is an economic principle that describes how opportunity costs increase as resources are applied. (In other words, each time resources are allocated, there is a cost of using them for one purpose over another.)

How does the law of increasing opportunity cost relate to an upward sloping supply curve?

With increased production, there is a higher opportunity cost that needs to be recovered with increased production. This can be only by charging a higher price. This means that the more the number of units sold, the higher price charged, which is what the upward slope of the supply curve shows.

How do increasing opportunity costs affect the shape of the production possibilities curve?

The Law of Increasing Opportunity Cost – We see in Figure 2.4 “The Combined Production Possibilities Curve for Alpine Sports” that, beginning at point A and producing only skis, Alpine Sports experiences higher and higher opportunity costs as it produces more snowboards. The fact that the opportunity cost of additional snowboards increases as the firm produces more of them is a reflection of an important economic law.

1. The law of increasing opportunity cost holds that as an economy moves along its production possibilities curve in the direction of producing more of a particular good, the opportunity cost of additional units of that good will increase.
2. We have seen the law of increasing opportunity cost at work traveling from point A toward point D on the production possibilities curve in Figure 2.4 “The Combined Production Possibilities Curve for Alpine Sports”.

The opportunity cost of each of the first 100 snowboards equals half a pair of skis; each of the next 100 snowboards has an opportunity cost of 1 pair of skis, and each of the last 100 snowboards has an opportunity cost of 2 pairs of skis. The law also applies as the firm shifts from snowboards to skis.

Suppose it begins at point D, producing 300 snowboards per month and no skis. It can shift to ski production at a relatively low cost at first. The opportunity cost of the first 200 pairs of skis is just 100 snowboards at Plant 1, a movement from point D to point C, or 0.5 snowboards per pair of skis.

We would say that Plant 1 has a comparative advantage in ski production. The next 100 pairs of skis would be produced at Plant 2, where snowboard production would fall by 100 snowboards per month. The opportunity cost of skis at Plant 2 is 1 snowboard per pair of skis.

1. Plant 3 would be the last plant converted to ski production.
2. There, 50 pairs of skis could be produced per month at a cost of 100 snowboards, or an opportunity cost of 2 snowboards per pair of skis.
3. The bowed-out shape of the production possibilities curve illustrates the law of increasing opportunity cost.

Its downwards slope reflects scarcity. Figure 2.5 “Production Possibilities for the Economy” illustrates a much smoother production possibilities curve. This production possibilities curve in Panel (a) includes 10 linear segments and is almost a smooth curve.

As we include more and more production units, the curve will become smoother and smoother. In an actual economy, with a tremendous number of firms and workers, it is easy to see that the production possibilities curve will be smooth. We will generally draw production possibilities curves for the economy as smooth, bowed-out curves, like the one in Panel (b).

This production possibilities curve shows an economy that produces only skis and snowboards. Notice the curve still has a bowed-out shape; it still has a negative slope. Notice also that this curve has no numbers. Economists often use models such as the production possibilities model with graphs that show the general shapes of curves but that do not include specific numbers. As we combine the production possibilities curves for more and more units, the curve becomes smoother. It retains its negative slope and bowed-out shape. In Panel (a) we have a combined production possibilities curve for Alpine Sports, assuming that it now has 10 plants producing skis and snowboards.

Even though each of the plants has a linear curve, combining them according to comparative advantage, as we did with 3 plants in Figure 2.4 “The Combined Production Possibilities Curve for Alpine Sports”, produces what appears to be a smooth, nonlinear curve, even though it is made up of linear segments.

In drawing production possibilities curves for the economy, we shall generally assume they are smooth and “bowed out,” as in Panel (b). This curve depicts an entire economy that produces only skis and snowboards.

What would cause a movement along the supply curve?

A rise or fall in the price of the commodity alone causes a movement along the supply curve (ceteris paribus).

What does the opportunity cost curve show?

Key Takeaways –

• When producing goods, opportunity cost is what is given up when you take resources from one product to produce another. The maximum amount that can be produced is illustrated by a curve on a graph.
• The production possibility frontier (PPF) is above the curve, illustrating impossible scenarios given the available resources.
• The PPF demonstrates that the production of one commodity may increase only if the production of the other commodity decreases.
• The PPF is a decision-making tool for managers deciding on the optimum product mix for the company.