1. Chapter 2: Opportunity costs
Scarcity
Economics is the study of how individuals and economies
deal with the fundamental problem of scarcity.
As a result of scarcity, individuals and societies must make
choices among competing alternatives.
Opportunity Cost
The opportunity cost of any alternative is defined as the
cost of not selecting the "next-best" alternative.

2. What Does Opportunity Cost Mean?
•
1. The cost of an alternative that must be
forgone in order to pursue a certain action.
• Put another way, the benefits you could have
received by taking an alternative action.

3. What Does Opportunity Cost Mean?
• 2. The difference in return between a chosen investment and one
that is necessarily passed up.
• Say you invest in a stock and it returns a paltry 2% over the year.
• In placing your money in the stock, you gave up the opportunity of
another investment - say, a risk-free government bond yielding 6%.
In this situation, your opportunity costs are 4% (6% - 2%).

4. Investopedia explains Opportunity Cost
•
1. The opportunity cost of going to college is the money you would have
earned if you worked instead.
• On the one hand, you lose four years of salary while getting your degree;
on the other hand, you hope to earn more during your career, thanks to
your education, to offset the lost wages.
Investopedia explains Opportunity Cost
Here's another example: if a gardener decides to grow
carrots, his or her opportunity cost is the alternative crop
that might have been grown instead
(potatoes, tomatoes, pumpkins, etc.).

5. Investopedia explains Opportunity Cost
• In both cases, a choice between two options
must be made. It would be an easy decision if
you knew the end outcome; however, the risk
that you could achieve greater "benefits" (be
they monetary or otherwise) with another
option is the opportunity cost.

6. Opportunity cost (Further Explanations)
• is the cost of any activity measured in terms of the value of
the best alternative that is not chosen (i.e., that is foregone).
• It is the sacrifice related to the second best choice available
to someone who has picked among several mutually exclusive
choices.
Opportunity cost
• Opportunity cost is a key concept in
economics, and has been described as
expressing "the basic relationship between
scarcity and choice".

7. Opportunity cost
• The notion of opportunity cost plays a crucial
part in ensuring that scarce resources are used
efficiently.
• Thus, opportunity costs are not restricted to
monetary or financial costs
• the real cost of output forgone, lost
time, pleasure or any other benefit that
provides utility should also be considered
opportunity costs

8. Marginal analysis
• Marginal benefit = additional benefit
resulting from a one-unit increase in the
level of an activity
• Marginal cost = additional cost associated
with one-unit increase in the level of an
activity

9. Net benefit
• Individuals are not expected to maximize benefit; nor
are they expected to minimize costs.
• Individuals are assumed to attempt to maximize the
level of net benefit (total benefit minus total cost)
from any activity in which they are engaged.

10. Production possibilities curve
• Assumptions:
– A fixed quantity and quality of available resources
– A fixed level of technology
– Efficient production (i.e., no unemployment and
no underemployment)

11. Law of diminishing returns
• Law of diminishing returns: output will
ultimately increase by progressively smaller
amounts when the use of a variable input
increases while other inputs are held constant.
Reasons for law of increasing cost
Law of diminishing returns
Specialized resources (heterogeneous
labor, land, capital, etc.)

12. Specialized resources in farming
• Some land, labor, and capital is better suited for
wheat production and some is better suited for corn
production
Specialization and trade
Adam Smith – economic growth is caused by increased
specialization and division of labor.

13. Gains from specialization and division of labor
• specialization in areas that match the skills and talents of
workers
• “learning by doing” – increase in productivity from task
repetition
• less time lost while switching from task to task

14. Absolute and comparative advantage
• Absolute advantage – an individual (or country) is
more productive than other individuals (or
countries).
• Comparative advantage – an individual (or country)
may produce a good at a lower opportunity cost than
can other individuals (or countries).

15. Free trade?
• If each country specializes in the production of
those goods in which it possesses a
comparative advantage and trades with other
countries, global output and consumption in
increased.