Question

What is opportunity cost? Explain with the help of a numerical example.

Answer 1

Opportunity cost refers to the value of a factor in its next best alternative use. Assuming that resources and technology remain constant, an economy is producing Good X and Good Y. Different combinations of production of Good X and Good Y are given in the production possibilities schedule:

Production Possibilities	Good X	Good Y	`MOC=(DeltaY)/(DeltaX)`
I	0	30	-
II	1	27	-3
III	2	21	-6
IV	3	12	-9
V	4	0	-12

 

At the production point II, 1 unit of Good X and 27 units of Good Y are produced. To produce an additional unit of Good X, 3 units of Good Y must be sacrificed.

Here, the opportunity cost is

Opportunitycost from ItoII `(DeltaY)/(DeltaX)="Amount of good Ysacrifed"/"Amount of good Xgained"=(27-30)/(2-1)=-3`

Thus, the opportunity cost of getting an additional unit of Good X is 3 units of Good Y.