Opportunity Cost

So far we have established the fact that people must make choices because scarcity exists. In other words,
because our seemingly unlimited wants push up against limited resources, some wants must go
unsatisfied. We must therefore choose which wants we will satisfy and which we will not. The most
highly valued opportunity or alternative forfeited when a choice is made is known as opportunity cost.
Every time you make a choice, you incur an opportunity cost. For example, you have chosen to read this
chapter. In making this choice, you denied yourself the benefits of doing something else. You could have
watched television, emailed a friend, taken a nap, eaten a few slices of pizza, read a novel, shopped for a
new computer, and so on. Whatever you would have chosen to do had you decided not to read this chapter
is the opportunity cost of your reading this chapter. For example, if you would have watched television
had you chosen not to read this chapter—if this was your next best alternative—then the opportunity cost
of reading this chapter is watching television.

Microeconomics and Macroeconomics

It has been said that the tools of microeconomics are microscopes, and the tools of macroeconomics are
telescopes. Macroeconomics stands back from the trees to see the forest. Microeconomics gets up close
and examines the tree itself, its bark, its limbs, and its roots. Microeconomics is the branch of economics
that deals with human behavior and choices as they relate to relatively small units—an individual, a firm,
an industry, a single market.

Macroeconomics is the branch of economics that deals with human behavior and choices as they relate
to an entire economy. In microeconomics, economists discuss a single price; in macroeconomics, they
discuss the price level. Microeconomics deals with the demand for a particular good or service;
macroeconomics deals with aggregate, or total, demand for goods and services. Microeconomics
examines how a tax change affects a single firm’s output; macroeconomics looks at how a tax change
affects an entire economy’s output.

Microeconomists and macroeconomists ask different types of questions. A microeconomist

might be interested in answering such questions as:

• How does a market work?

• What level of output does a firm produce?
• What price does a firm charge for the good it produces?
• How does a consumer determine how much of a good he or she will buy?
• Can government policy affect business behavior?
• Can government policy affect consumer behavior?
On the other hand, a macroeconomist might be interested in answering such questions as:

• How does the economy work?

• Why is the unemployment rate sometimes high and sometimes low?
• What causes inflation?
• Why do some national economies grow faster than other national economies?
• What might cause interest rates to be low one year and high the next?
• How do changes in the money supply affect the economy?
• How do changes in government spending and taxes affect the economy?
Production Possibilities
Frontier (PPF)
Represents the possible combinations of two goods that can be produced in a certain period of time under
the conditions of a given state of technology and fully employed resources.

PPF Drawing

Each combination represents a different point. The curved line that connects points A–D is the production
possibilities frontier. In this case, the production possibilities frontier is bowed outward (concave
downward) because the opportunity cost of television sets increases as more sets are produced

Bowed-outward PPF = Increasing opportunity costs

To illustrate, let’s start at point A, where the economy is producing 50,000 computers and 0 television
sets, and move to point B, where the economy is producing 40,000 computers and 20,000 television sets.
What is the opportunity cost of a television set over this range? We see that 20,000 more television sets
are produced by moving from point A to point B but at the cost of 10,000 computers. This means for
every 1 television set produced, 1/2 computer is forfeited. Thus, the opportunity cost of 1 television set is
1/2 computer. Now let’s move from point B, where the economy is producing 40,000 computers and
20,000 television sets, to point C, where the economy is producing 25,000 computers and 40,000
television sets
Economic Concepts Within a PPF Framework

The PPF framework is useful for illustrating and working with economic
concepts. This section discusses seven economic concepts in
terms of the PPF framework (see Exhibit 4).
Productive Efficiency
The condition where the maximum output is produced with given resources and technology.

Productive Inefficiency The condition where less than the maximum output is produced with given
resources and technology. Productive inefficiency implies that more of one good can be produced without
any less of another good being produced

ECONOMIC GROWTH Economic growth refers to the increased productive capabilities

of an economy. It is illustrated by a shift outward in the production possibilities
frontier. Two major factors that affect economic growth are (1) an increase in the quantity
of resources and (2) an advance in technology.
With an increase in the quantity of resources (e.g., through a new discovery of
resources), it is possible to produce a greater quantity of output. In Exhibit 6, an increase
in the quantity of resources makes it possible to produce both more military goods and
more civilian goods. Thus, the PPF shifts outward from PPF1 to PPF2.
Technology refers to the body of skills and knowledge concerning the use of resources
in production. An advance in technology commonly refers to the ability to produce more
output with a fixed quantity of resources or the ability to produce the same output with
a smaller quantity of resources.