Opportunity Cost and Monetary Cost
The opportunity cost of a decision is the value of the next best alternative this decision forces a person to do without, while the monetary cost is the market price of goods. Therefore, the opportunity cost of buying a blackberry is not its market price, but the value of the other things that could be purchased instead. Taking into consideration the opportunity cost of pending decisions, one has to make a rational choice. A rational choice is one that gives the greatest benefit, having weighed the benefits of the decision, against its opportunity cost.
The principle of opportunity cost can be made more vivid by using a production possibility frontier. This is a graph which shows the possible combinations of goods that a producer can manufacture given the available resources and the current level of technology. The following production possibility frontier shows the possible combinations of oranges and sugarcane an agriculturer can yield on a plot of land.
Figure 1.1 above shows a production possibility frontier.
The table below lists the combination of oranges and sugarcanes depicted in the production possibility frontier.
|Tonnes of Oranges||Tonnes of Sugarcane||Points|
The production possibility frontier shows that the greater the quantity of one good that is produced, the smaller the quantity that can be produced of the other good. If the agriculturer decides to grow only oranges, the yield will be 40,000 tonnes, but if he/she decides to grow 30,000 tonnes, then 25,000 tonnes of sugarcane can also be yielded. Therefore, the opportunity cost of obtaining 25,000 tonnes of sugarcane is the 10,000 tonnes of oranges the agriculturer must forgo.
Production possibility frontiers also illustrate the concept of efficiency. The combinations of goods depicted on the curve are attainable only if all the resources are fully employed, with the most efficient means of production possible. In reality, there is no guarantee that resources will be fully employed or that the latest technology is used in production. Where resources are not fully employed or the latest technology is not used, the production point will lie below the curve. This is point F in the production possibility frontier below.
Figure 1.2 above shows a production possibility frontier with production point F.