Opportunity Cost and Production Possibilities Overheads

1. Opportunity Cost and Production Possibilities Overheads

2. Opportunity Cost The opportunity cost of any choice is what we give up when we make that choice

3. The opportunity cost of any good or service is its value in its next best alternative use. For example, the opportunity cost of the service of an input used in the production of any particular commodity is the maximum amount that the input would produce of any other commodity.

4. Examples of Opportunity Cost 1. Farmer who raises hogs and considers using his own corn to feed the hogs 2. Recent college graduate who chooses a high paying job in Chicago when his family all live in Iowa and he plans to visit them once or twice a month

5. Examples of Opportunity Cost 3. Businessman who hires a maid to clean his house so he has time to do more consulting in the evening 4. Woman who is considering whether to stay home and take care of her children or work at a job paying $9.50 per hour and hire a baby sitter

6. Examples of Opportunity Cost 5. Seamstress who chooses to make blue shirts instead of striped shirts 6. A landowner decides to farm his own land instead of renting it to a neighbor

7. Individuals who have a high value of time - either due to high income, or personal preference - have a high opportunity cost for alternative activities

8. Principle of Opportunity Cost All economic decisions taken by individuals or society are costly The correct way to measure the cost of a choice is its opportunity cost — that which is given up to make the choice

9. The Process of Production Uses Inputs Produces Outputs

10. An input is a good or service that is employed in the production process Inputs are denoted by x or by x1, x2, … , xn

11. An output is a good or service that is the output of a particular production process Outputs are denoted by y or by y1, y2, … , ym

12. Production Technologies • Thetechnology set(technology for short) for a given production process is defined as the setofall input and output combinations • such that theset of outputs y • can be produced from • the given set ofinputs x

13. The technology set is the set of feasible input and output combinations

14. Inputs Used for Producing Holes in the Ground Output for the Digging Technology Some number of postholes or trenches

15. Elements of the Digging Technology Set

16. Elements of the Digging Technology Set

17. Inputs Used for Producing Pancakes

18. The Output (single) for the Pancake Technology Some number of pancakes served on a plate with butter and syrup along with a knife and fork

19. One Element of the Pancake Technology Set

20. The Producible Output Set P(x) The producible output set P(x) is the set of all combinations of outputs, that are obtainable from a fixed level of inputs.

21. Fix the level of y1 at some level, say Construction of the Producible Output Set Fix all inputs at a specific level For that level of y1, list all feasible levels of y2 , then repeat this for all other levels of y1.

22. 10 5 14 12 Producible Output Set for Pancakes and Crepes pancakes P(x) 0 0 crepes

23. Law of Increasing Opportunity Cost The more of something we produce, the greater is the opportunity cost of producing still more.

24. Vector of Inputs for Corn and Soybeans

25. Possible Output Combinations for Corn and Soybeans Corn Soybeans 16,000 0 0 4,000 9,600 3,000

26. The Boundary of the Set is Concave 4,000 3,000 9,600 16,000 Producible Output Set for Corn and Soybeans soybeans P(x) 0 corn 0

27. Why concavity of the boundary? Some inputs are better suited to some uses Some allocated inputs may be shared (between uses)

28. New Digging Technology Set 2 identical semi-skilled workers 1 shovel 1 post hole digger

29. Input-Output Coefficients Post Holes/Hour Trenches/Hour Shovel 4 2 Post Hole Digger 6 1/2

30. Some Efficient Sample Points Each worker can only use one tool 10 post holes - No trenches 0 post holes - 2.5 trenches 6 post holes - 2 trenches 8 post holes - 1 trench 3 post holes - 2.25 trenches

31. 12 (0.5, 9) 10 Postholes (2.25, 3) (1,8) (2,6) (1.25,7.5) 8 6 4 2 0 0 0.5 1 1.5 2 2.5 3 Trenches Postholes and Trenches

32. Some Inefficient Sample Points 5 post holes - 1.25 trenches (1/2 time on each) 4 post holes - 0.5 trenches (“wrong” tasks) 3 post holes - 1 trench (rest 1/2 time)

33. 12 (0.5, 9) 10 Postholes (2.25, 3) (1,8) (2,6) (1.25,7.5) 8 ¼ holes ½ each (1.25, 5) 6 Wrong Tasks 1 7/8, 2.5 4 (0.5, 4) (1, 3) 2 Shirk 0 0 0.5 1 1.5 2 2.5 3 Trenches Postholes and Trenches

34. Buttons on right 12 Linear Producible Output Set P(x) Buttons on left 12 Shirts with buttons on the left and on the right

35. Production Possibility Frontier • The boundary of the producible output set is called • the production possibility frontier y1 PPF P(x) y2

36. Efficient and Inefficient Points Points in P(x) that are on the frontier are called efficient points Points in the interior of the set P(x) are called inefficient points

37. We say that an input-output combination is technically efficient if the maximum possible output is being produced given the inputs. We say that an input-output combination is technically efficient if it is on the production possibility frontier.

38. PPF Inefficient Production Points y1 P(x) y2

39. 12 10 Postholes (2.25, 3) (1,8) (2,6) 8 6 Wrong Tasks 4 Wrong Division 2 Shirk 0 0 0.5 1 1.5 2 2.5 3 Trenches Postholes and Trenches (1.25,7.5)

40. No Free Lunch Once we are on the production possibility frontier, we cannot produce more of one output, without producing less of another output

41. 12 10 Postholes 8 6 4 2 0 0 0.5 1 1.5 2 2.5 3 Trenches Postholes and Trenches

42. 12 10 Postholes 8 6 4 2 0 0 0.5 1 1.5 2 2.5 3 Trenches Postholes and Trenches

43. A Free Lunch • If we are at a point in the producible output set • that is not on the boundary, • then we can get more output from the same input bundle and thus there is a “free lunch.”

44. 12 (0.5, 9) 10 Postholes (2.25, 3) (1,8) (2,6) 8 6 Wrong Tasks 4 Wrong Division 2 Shirk 0 0 0.5 1 1.5 2 2.5 3 Trenches Postholes and Trenches (1.25,7.5)

45. The End