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The concept of opportunity cost

Economists use the term opportunity cost    to indicate what must be given up to obtain something that is desired. The idea behind opportunity cost is that the cost of one item is the lost opportunity to do or consume something else; in short, opportunity cost is the value of the next best alternative. For Alphonso, the opportunity cost of a burger is the four bus tickets he would have to give up. He would decide whether or not to choose the burger depending on whether the value of the burger exceeds the value of the forgone alternative—in this case, bus tickets. Since people must choose, they inevitably face tradeoffs in which they have to give up things they desire to get other things they desire more.

View this website for an example of opportunity cost—paying someone else to wait in line for you.

A fundamental principle of economics is that every choice has an opportunity cost. If you sleep through your economics class (not recommended, by the way), the opportunity cost is the learning you miss from not attending class. If you spend your income on video games, you cannot spend it on movies. If you choose to marry one person, you give up the opportunity to marry anyone else. In short, opportunity cost is all around us and part of human existence.

The following Work It Out feature shows a step-by-step analysis of a budget constraint calculation. Read through it to understand another important concept—slope—that is further explained in the appendix The Use of Mathematics in Principles of Economics .

Understanding budget constraints

Budget constraints are easy to understand if you apply a little math. The appendix The Use of Mathematics in Principles of Economics explains all the math you are likely to need in this book. So if math is not your strength, you might want to take a look at the appendix.

Step 1: The equation for any budget constraint is:

Budget = P 1  × Q 1  + P 2 × Q 2

where P and Q are the price and quantity of items purchased and Budget is the amount of income one has to spend.

Step 2. Apply the budget constraint equation to the scenario. In Alphonso’s case, this works out to be:

Budget = P 1 × Q 1 + P 2 × Q 2 $10 budget = $2 per burger × quantity of burgers + $0.50 per bus ticket × quantity of bus tickets $10 = $2 × Q burgers  + $0.50 × Q bus tickets

Step 3. Using a little algebra, we can turn this into the familiar equation of a line:

y  =  b + mx

For Alphonso, this is:

$10  =  $2 × Q burgers  +  $0.50  ×  Q bus tickets

Step 4. Simplify the equation. Begin by multiplying both sides of the equation by 2:

2 × 10  =  2 × 2 × Q burgers  + 2 × 0.5 × Q bus tickets   20  =  4 × Q burgers  + 1 × Q bus tickets

Step 5. Subtract one bus ticket from both sides:

20 – Q bus tickets = 4 × Q burgers

Divide each side by 4 to yield the answer:

5 – 0.25 × Q bus tickets = Q burgers or Q burgers = 5 – 0.25 × Q bus tickets

Step 6. Notice that this equation fits the budget constraint in [link] . The vertical intercept is 5 and the slope is –0.25, just as the equation says. If you plug 20 bus tickets into the equation, you get 0 burgers. If you plug other numbers of bus tickets into the equation, you get the results shown in [link] , which are the points on Alphonso’s budget constraint.

Point Quantity of Burgers (at $2) Quantity of Bus Tickets (at 50 cents)
A 5 0
B 4 4
C 3 8
D 2 12
E 1 16
F 0 20

Step 7. Notice that the slope of a budget constraint always shows the opportunity cost of the good which is on the horizontal axis. For Alphonso, the slope is −0.25, indicating that for every four bus tickets he buys, Alphonso must give up 1 burger.

There are two important observations here. First, the algebraic sign of the slope is negative, which means that the only way to get more of one good is to give up some of the other. Second, the slope is defined as the price of bus tickets (whatever is on the horizontal axis in the graph) divided by the price of burgers (whatever is on the vertical axis), in this case $0.50/$2 = 0.25. So if you want to determine the opportunity cost quickly, just divide the two prices.

Questions & Answers

describe the producer's scarce resources.. I.e land,Labour,capital and enterprise
Alfhah Reply
What are human behaviour?
Regina Reply
how can you describe economic goods in a much better easier way?
Alfhah Reply
what is deman and supply
Aruna Reply
Demand can be defined as the ability and willingness to buy commodities in a given price of goods and services in a particular period of time
Alasana
supply refers to the ability and willingness to offered commodities for sale in a given price of goods and services in a period of time .
Alasana
Demand can refer to the ability and willingness to purchase a commodity at a giving price and time.
habib
what must the producer do if total costs exceed total revenue
Mmusi Reply
raise price
Nguyen
scarcity resources sample
nawala Reply
what's scarcity
tumelo Reply
what are the two types of economic theory's?
Lizabeth Reply
i thick it is microeconomic theory and macroeconomic theory. or it can be normative and positive economic theories.
Deep
yes^
Nguyen
with diagrams show thé change in prices in thé different time period that can result in an increase in demande
Fankam Reply
define momentary period
Fankam
What is a monopsony?
Allan Reply
monopsony is a situation where only one buyer is available in the market
The
And with many sellers?
Allan
oligopsony
The
to be more specific, oligopsony is a situation with many sellers but few buyers
The
Thank you
Allan
economic is tha process of banking
hashmat Reply
Pls can u explain it into details
Praise
Cause I don't understand what you are saying
Praise
brownies price is 5$ quantity demand is 5000$ supplied is 3000 if brownies are not taxed how many are consumed?
Fel Reply
what is unemployment
Rita Reply
ok so what would u say is supply in your own terms
Odessa Reply
Ok
fedaa
ya
Lal
why the demand curve is downwards sloping and supply upward sloping
Odessa Reply
the dd curve is downward sloping because consumers dd less when price is high and vice versa the ss curve is upward sloping suppliers are willing to produce more when prices are high
Clifford
what is dead weight loss
jeremy
when the prices of supplies slop upward then the prices of demand curve will increases downward
Kerubino

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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