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Understanding Opportunity Cost in Economics

Chapter 3 discusses the concept of opportunity cost, which is the cost of choosing one alternative over the best alternative forgone. It highlights how opportunity cost influences decision-making for consumers, workers, producers, and governments, emphasizing the need to consider what is sacrificed in various choices. The chapter also distinguishes between economic goods, which have an opportunity cost, and free goods, which do not.

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15 views4 pages

Understanding Opportunity Cost in Economics

Chapter 3 discusses the concept of opportunity cost, which is the cost of choosing one alternative over the best alternative forgone. It highlights how opportunity cost influences decision-making for consumers, workers, producers, and governments, emphasizing the need to consider what is sacrificed in various choices. The chapter also distinguishes between economic goods, which have an opportunity cost, and free goods, which do not.

Uploaded by

Vihaan goel
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Chapter 3

16
Opportunity cost
Learning objectives
By the end of this chapter you will be able to:
■ define opportunity cost
■ give examples of opportunity cost in different contexts
■ explain the influence of opportunity cost on the decision making of consumers, workers,
producers and governments

Introducing the topic


There are many subjects that schools could teach. For example, Cambridge International
Examinations offers more than 70 subjects at IGCSE. Each school offers only a proportion
of the subjects on offer. Why is this? It is because schools do not have enough classrooms,
teachers and equipment to teach all subjects, for example a classroom can be used to teach
English or economics in the same room, but not at the same time.
There are not enough economic resources to produce all the goods and services we would
desire, as we saw in Chapter 1. Land, labour, capital and enterprise are scarce and so
decisions have to be made about the method and purpose of their use. In deciding what
to use the classroom for, and in making other decisions, the concept of opportunity cost is
important.
Chapter 3: Opportunity cost

3.1 The meaning of opportunity cost


When we decide to do one thing, we are deciding not to do something else. To ensure that we
make the right decisions, it is important that we consider the alternatives, particularly the best
alternative. Opportunity cost is the cost of a decision in terms of the best alternative given KEY TERM
up to achieve it, for example there are a variety of things you could do tomorrow between
Opportunity cost:
5 pm and 6 pm. These may be to go shopping, to read a chapter of an economics book, to do
the best alternative
some paid work or to visit a friend. You may narrow those choices down to reading the chapter forgone.
or visiting a friend. You will have to consider very carefully which one will give you the best
return. If you choose to read the chapter, you will not be able to visit your friend and vice versa.

LINK

Chapter 4.3 Movements


along a PPC

TIP
In explaining
opportunity cost, it is
always useful to give
an example.

17

Reading has an opportunity cost

3.2 Influence of opportunity cost on


decision making
Opportunity cost and consumers
Consumers are buyers and users of goods and services. We are all consumers. The vast
majority of us cannot buy everything we like. You may, for example, have to choose which
economics dictionary to buy. You will probably consider a number of different ones, taking
into account their prices. The choice will then tend to settle on two of them. You are likely to
select the one with the widest and the most accurate informative coverage. The closer the
two dictionaries are in quality and price, the harder the choice will be.
Opportunity cost and workers
Undertaking one job involves an opportunity cost. People employed as teachers might also
be able to work as civil servants. They need to carefully consider their preference for the jobs
available. This would be influenced by a number of factors, including the wage paid, chances
of promotion and the job satisfaction to be gained from each job. If the pay of civil servants or
their working conditions improve, the opportunity cost of being a teacher will increase. It may
even increase to the point where some teachers resign and become civil servants instead.
Cambridge IGCSE Economics

GROUP ACTIVITY 1

In your group, discuss why the opportunity cost of working as an accountant is likely to be
higher than that of working as a window cleaner.

Opportunity cost and producers


Producers have to decide what to make. If a farmer uses a field to grow sugar beet, he cannot
keep cattle on that field. If a car producer uses some of his factory space and workers to
produce one model of a car, he cannot use the same space and workers to make another
model of the car at the same time.
In deciding what to produce, private sector firms will tend to choose the option which will
give them the maximum profit. They will also take into account the demand for different
products and the cost of producing those products.

Opportunity cost and the government


LINK
Government has to carefully consider its expenditure of tax revenue on various things.
If it decides to spend more on education, the opportunity cost involved may be a
Chapter 4.3 Movements reduced expenditure on healthcare. It could, of course, raise tax revenue in order to spend
along a PPC
more on education. In this case, the opportunity cost would be put on the taxpayers.
To pay higher taxes, people may have to give up the opportunity to buy certain products
or to save.
18

TIP
Opportunity cost is one of the most important concepts in economics. You will find that you can
use it in answers to a relatively wide range of structured questions.

INDIVIDUAL ACTIVITY 1

In each of the following cases, consider what might be the opportunity cost.
a A person wanting to buy fruit, decides to buy apples.
b A person decides to study economics at a university.
c A factory is built on farm land.
d A woman has a television set which cost her $800 two years ago. A new set would cost her
$1000 and she could sell her television set for $450. What is the opportunity cost of keeping
the old television?

LINK
Economic goods and free goods
As resources are used to produce economic goods, their production involves an opportunity
Chapter 1.2 Economic
goods and free goods cost. In contrast, no resources are used to produce free goods and so they do not involve an
opportunity cost.
Chapter 3: Opportunity cost

Summary
You should know:
■ Opportunity cost is an important concept as it emphasises that people have to consider what they are
sacrificing when they decide what to buy, what job to do and what to produce, and when governments
are deciding what to spend their tax revenue on.
■ Economic goods have an opportunity cost whereas free goods do not.

Multiple choice questions


1 What is meant by ‘opportunity cost’?
A The best alternative forgone
B The cost of the item selected
C The cost of exploring business opportunities
D The labour used in producing the product

2 A person decides to go to the university for three years, to study economics. If he had not
gone, he could have taken up a job which would have paid him $15 000 a year. After he
graduates he expects to find a job paying him $40 000 a year. What is the opportunity cost
of going to the university for him?
A $15 000 B $40 000
19
C $45 000 D $120 000

3 What are the characteristics of a free good?

A Has an opportunity cost Takes resources to produce it


B Has an opportunity cost Takes no resources to produce it
C Has no opportunity cost Takes no resources to produce it
D Has no opportunity cost Takes resources to produce it

4 On his birthday, Kamran receives $200 from his aunt, $50 of which he decides to save. He
is taken out by his father for lunch. His father pays the bill. Kamran spends the afternoon
playing football. Which of these activities involves an opportunity cost?

Eating the free lunch Playing football Saving


A No No No
B No No Yes
C No Yes Yes
D Yes Yes Yes

Four-part question
a Define opportunity cost. (2)
b Explain why opportunity cost is an important concept for producers. (4)
c Analyse what effect the building of an airport may have on the decision of how to use an
area of land nearby. (6)

Common questions

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Opportunity cost influences consumer decision-making by forcing consumers to consider the best alternative forgone when making purchases. Consumers cannot buy everything they desire due to limited resources, so they must evaluate different options based on factors such as price and quality. For instance, when choosing an economics dictionary, consumers will compare the coverage and price of various dictionaries and select the one that offers the best value, considering what they forgo in the process .

Opportunity cost shapes government decision-making by necessitating trade-offs in resource allocation and public expenditure. Governments must decide between various initiatives, such as spending on education versus healthcare. Each choice entails opportunity costs, as increasing funds for one area means reducing them for another unless tax revenues are increased, causing consumers to forgo purchases or savings. An increase in education spending may mean less for healthcare unless actions are taken to offset the cost via increased taxes .

Understanding opportunity cost is crucial for policymakers in infrastructure planning to justify resource allocation and manage public expectations. Building an airport involves significant investment and land use that could have alternative uses like housing or industry. The opportunity cost includes potential economic opportunities from alternative land use and the cost implications of diverting resources from other public services. Recognizing these trade-offs helps policymakers in making informed decisions that optimize economic and social benefits .

Opportunity cost impacts workers by influencing their choice between different job offers based on what they forego. Workers must consider potential wages, chances of promotion, job satisfaction, and other benefits when evaluating opportunities. For instance, a teacher contemplating a switch to a civil servant role might assess improved pay or working conditions. If these improve significantly, the opportunity cost of remaining a teacher increases, potentially leading them to resign and transition to the other role .

The opportunity cost of working in high-skill professions like accountancy is generally higher than in low-skill jobs due to potential alternative earnings and opportunities. Accountants might forgo higher alternate earnings, potential career advancement, and specialization opportunities compared to window cleaners, whose job market might offer fewer alternatives. The opportunity cost reflects the differences in wage potential and career trajectory available to skilled professionals that are not typically present in low-skill occupations .

Opportunity cost influences a producer's decision-making within the framework of a Production Possibility Curve (PPC) by illustrating the trade-offs between different goods. When a producer allocates resources to increase production of one good, they forego the production of another, reflected by a movement along the PPC. This trade-off is the opportunity cost of allocating resources towards one product over another, highlighting efficiency and optimal allocation in production processes .

Opportunity cost influences personal life decisions by prompting individuals to consider the best use of their limited time and resources. For instance, choosing a hobby like playing music over participating in sports involves considering the benefits such as enjoyment, skill development, and relaxation against what is sacrificed, like physical fitness from sports. Similarly, deciding to spend an hour reading a book versus socializing with friends requires evaluating the immediate pleasure against the benefits of knowledge acquisition or social well-being .

Opportunity cost plays a significant role in deciding to attend university as it involves weighing immediate earnings against potential future benefits. For example, a student foregoing a $15,000 annual salary by attending university incurs an opportunity cost of $45,000 over three years. This decision is made with the expectation of higher future earnings, such as a $40,000 annual salary post-graduation. The opportunity cost involves delaying earnings but potentially improving career prospects and earnings capacity in the long run .

Opportunity cost is applicable to economic goods because their production entails using scarce resources that could have been deployed elsewhere, thus forgoing other potential uses. Economic goods require resource allocation and decision-making involving trade-offs. In contrast, free goods do not involve opportunity costs as they do not require resource allocation for their production, allowing their consumption without foregoing other uses .

Producers use opportunity cost to maximize profits by choosing production options that offer the highest potential return. Private sector firms consider demand and production costs for different products, opting for the one that brings better profitability. For example, a farmer might choose to grow sugar beet instead of keeping cattle on the same land, based on the expected return. A car manufacturer might allocate factory resources to a model with higher demand or lower production costs, forsaking another model in the process .

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