Opportunity cost: every choice gives something up
In Topic 1.1, Scarcity, you saw that resources are limited but wants are not. So every economy must choose what to produce. Choosing more of one thing means producing less of something else. This is a tradeoff.
Key definitions:
- Opportunity cost: the value of the next best alternative you give up when you make a choice. It is not every alternative added together, only the best one you did not choose.
- Tradeoff: the choice between alternatives, where getting more of one thing means getting less of another.
- Production possibilities curve (PPC): a graph that shows the maximum combinations of two goods (or two groups of goods) an economy can produce in a given period, when it uses all its resources fully and efficiently, with its current technology.
- Efficiency (productive efficiency): producing the most output possible from the resources available, with none wasted or left idle. On a PPC, every point on the curve is efficient.
- Inefficiency: producing less than is possible, because some resources are unemployed or badly used. On a PPC, any point inside the curve is inefficient.
- Unattainable point: a combination outside the curve. The economy cannot produce it with its present resources and technology.
What the PPC model assumes
A PPC is a simple model, so it makes four assumptions:
- The economy produces only two goods (or two categories, such as capital goods and consumer goods).
- The quantity and quality of resources (land, labour, capital, entrepreneurship) are fixed.
- Technology is fixed.
- The curve shows production in one time period.
Because resources and technology are held fixed, the PPC shows the economy’s capacity at full employment of its resources. If any of these change, the whole curve moves.
Our fictional economy: Valdoria
Valdoria is a fictional country. It produces only bicycles and rice. Bicycles are measured in thousands; rice is measured in thousands of tonnes. The table shows seven combinations on Valdoria’s PPC. All data are fictional.
| Point | Bicycles (thousands) | Rice (thousand tonnes) |
|---|---|---|
| A | 0 | 100 |
| B | 10 | 96 |
| C | 20 | 88 |
| D | 30 | 76 |
| E | 40 | 60 |
| F | 50 | 36 |
| G | 60 | 0 |
At A, every resource makes rice. At G, every resource makes bicycles. Every point from A to G uses all of Valdoria’s resources, so every point is efficient. Moving from one point to another is a movement along the curve: the economy reallocates its resources, but its capacity does not change.
The curve is also a picture of scarcity. Valdoria cannot reach any point beyond it, and the curve slopes downward: to get more bicycles, it must give up some rice.
Calculating opportunity cost
When an economy moves along its PPC, it gains some of one good and gives up some of the other.
Total opportunity cost = the amount of the other good given up.
Opportunity cost per unit = amount of the other good given up ÷ number of extra units gained
Always state what is given up and in what units. “The opportunity cost of one bicycle is 1.2 tonnes of rice” is a complete answer. “1.2” on its own is not.
The slope of the PPC (ignoring the minus sign) is the opportunity cost of the good on the horizontal axis, measured in the good on the vertical axis. The opportunity cost of the vertical-axis good is the reciprocal: 1 ÷ that slope.
Worked example 1: opportunity cost from a PPC table
Question. Use Valdoria’s table. (a) What is the opportunity cost of moving from B to D? (b) Calculate the opportunity cost of each extra 10 thousand bicycles, per bicycle. What happens to it, and what does that tell you about the shape of the curve? (c) What is the opportunity cost of one tonne of rice when moving from D to C? (d) Classify points W (20, 60) and X (50, 60).
(a) From B to D, bicycles rise from 10 to 30 thousand (a gain of 20 thousand). Rice falls from 96 to 76 thousand tonnes (a loss of 20 thousand tonnes). Total opportunity cost = 20 thousand tonnes of rice. Per bicycle: 20 ÷ 20 = 1 tonne of rice per bicycle.
(b) Work through the table one step at a time.
| Move | Extra bicycles (thousands) | Rice given up (thousand tonnes) | Opportunity cost per bicycle |
|---|---|---|---|
| A → B | 10 | 100 − 96 = 4 | 4 ÷ 10 = 0.4 tonnes |
| B → C | 10 | 96 − 88 = 8 | 0.8 tonnes |
| C → D | 10 | 88 − 76 = 12 | 1.2 tonnes |
| D → E | 10 | 76 − 60 = 16 | 1.6 tonnes |
| E → F | 10 | 60 − 36 = 24 | 2.4 tonnes |
| F → G | 10 | 36 − 0 = 36 | 3.6 tonnes |
The opportunity cost of a bicycle rises as Valdoria makes more bicycles. The last 10 thousand bicycles cost 36 thousand tonnes of rice, nine times as much as the first 10 thousand (4 thousand tonnes). This is increasing opportunity cost, and it is why the curve gets steeper from A to G: it is bowed outward (concave to the origin).
(c) From D to C, rice rises by 88 − 76 = 12 thousand tonnes, and bicycles fall by 30 − 20 = 10 thousand. Per tonne of rice: 10 ÷ 12 = 0.83 bicycles.
(d) At 20 thousand bicycles the most rice Valdoria can make is 88 thousand tonnes (point C). W has only 60, so W is inside the curve: inefficient. Some resources are unemployed or badly used. At 50 thousand bicycles the most rice is 36 thousand tonnes (point F). X needs 60, so X is outside the curve: unattainable with current resources and technology.
Check. Moving from W to C gains 28 thousand tonnes of rice and gives up no bicycles. Moving from W to E gains 20 thousand bicycles and gives up no rice. Putting idle resources to work has no opportunity cost in the PPC model. That is why inefficient points are wasteful.
Why the shape depends on opportunity cost
The shape of a PPC tells you how the opportunity cost changes as you produce more of one good.
- Constant opportunity cost → straight line. Resources are equally good at making both goods. Every extra unit of X costs the same amount of Y, so the slope never changes.
- Increasing opportunity cost → bowed outward (concave to the origin). Resources are specialised: some are much better at one good than the other. Valdoria first moves the workers and land that are best at bicycles and worst at rice, so the first bicycles cost little rice. Later it must move rice farmers and paddy fields that are excellent at rice and poor at bicycles, so each extra bicycle costs much more rice. This is the most common shape.
- Decreasing opportunity cost → bowed inward (convex to the origin). Each extra unit of X costs less Y than the one before. This is less common. It can happen when resources become more productive the more they specialise in one good, for example because workers learn and costs spread over larger output.
Shifts of the PPC: growth and contraction
A shift of the PPC means the economy’s capacity has changed. Two kinds of change shift it:
- Changes in the factors of production (the quantity or quality of land, labour, capital and entrepreneurship). Examples: a larger labour force, more machines and roads, new natural resources, better education and skills.
- Changes in productivity or technology, so the same resources can produce more.
Economic growth shifts the PPC outward. Points that were unattainable become attainable. Economic contraction (a fall in capacity) shifts it inward, for example after a natural disaster or war destroys capital, or when the labour force shrinks.
A change that helps only one good shifts only that good’s end of the curve. The curve pivots outward along that good’s axis.
Capital goods today, growth tomorrow. If the two goods are capital goods (machines, factories) and consumer goods, a choice to make more capital goods now has an opportunity cost in consumer goods today. But the extra capital adds to the factors of production, so the PPC tends to shift further outward in the future.
Worked example 2: constant opportunity cost and a technology change
Question. Kestria is another fictional country. With all its resources it can produce either 120 thousand tonnes of rice or 40 thousand bicycles, or any combination on the straight line between them. (a) Find the opportunity cost of one bicycle and of one tonne of rice. (b) If Kestria makes 25 thousand bicycles, how much rice can it make? (c) A new technology lets Kestria make up to 60 thousand bicycles, with no change in rice production. Find the new opportunity costs and the rice Kestria can make alongside 25 thousand bicycles. Explain the result.
(a) Giving up all 120 thousand tonnes of rice gains 40 thousand bicycles. One bicycle costs 120 ÷ 40 = 3 tonnes of rice. One tonne of rice costs 40 ÷ 120 = ⅓ of a bicycle (about 0.33). The PPC is a straight line, so these costs are constant at every point.
(b) 25 thousand bicycles cost 25 × 3 = 75 thousand tonnes of rice. Rice = 120 − 75 = 45 thousand tonnes. This is point P in Figure 3.
(c) Now one bicycle costs 120 ÷ 60 = 2 tonnes of rice, and one tonne of rice costs 60 ÷ 120 = 0.5 bicycles. With 25 thousand bicycles: rice = 120 − 25 × 2 = 70 thousand tonnes (point Q).
Interpretation. The PPC pivots outward along the bicycle axis; the rice intercept stays at 120. Kestria can now have 25 thousand more tonnes of rice with the same number of bicycles. Bicycles need fewer resources than before, so resources are freed to grow rice. The technology improved only bicycles, yet Kestria can have more of both goods. Bicycles became cheaper in terms of rice (3 → 2 tonnes), so rice became dearer in terms of bicycles (⅓ → ½ bicycle).
Check. At 45 thousand tonnes of rice, Kestria could now make (120 − 45) ÷ 2 = 37.5 thousand bicycles instead of 25 thousand. The new line is to the right of the old one at every level of rice except 120, where both lines meet.
Common misconceptions
- “Unemployment shifts the PPC inward.” No. It moves the economy to a point inside the curve. The curve shifts inward only if resources or productivity are lost.
- “More consumer goods means a shift.” Choosing a different combination is a movement along the curve, not a shift.
- “Opportunity cost is the money price.” It is the next best alternative given up, here measured in the other good.
- “Opportunity cost is the sum of all alternatives.” Only the next best alternative counts.
- Forgetting to divide. “20 thousand tonnes” is a total; per unit, divide by the number of extra units gained.
- Inverting the ratio. For the cost of one bicycle, put rice given up on top and bicycles gained on the bottom.
- “A bowed-out PPC means decreasing opportunity cost.” Bowed outward means increasing opportunity cost.
- “Moving from inside to the curve has an opportunity cost.” Using idle resources costs nothing in the model.
- “Technology for one good shifts the whole curve evenly.” It pivots the curve outward along that good’s axis only.
- Unlabelled graphs. Label both axes with the goods (and units) and label the curve “PPC”.
Where this leads
Next, in Topic 1.3, you will use opportunity costs to see why countries specialise and gain from trade: see Comparative Advantage and Gains from Trade. Later in the course the PPC returns as a picture of full-employment output and long-run growth. Try the practice questions now, then use the revision notes and the checklist to consolidate.
Quick questions
Does unemployment shift the PPC inward?
No. Unemployed workers still exist, so the economy's capacity is unchanged. Extra unemployment, such as in a recession, puts the economy at a point inside the PPC. The curve shifts inward only if the economy actually loses resources or productivity.
Why is the PPC usually drawn bowed outward?
Because resources are not equally good at producing both goods. As an economy makes more of one good, it has to move resources that are less and less suited to it, so each extra unit costs more of the other good.