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