Question

Explain the meaning of opportunity cost with the help of a production possibility schedule.

Answer 1

Opportunity cost describes the cost of making a choice, in terms of the value of the next best alternative that is forgone. When some of the given resources are shifted from use 1 to use 2, the gain of output in use 2 is accomplished with a loss of output in use 1. Loss of output in use 1 is the opportunity cost of gain of output in use 2. The given table illustrates how opportunity cost arises.

$\begin{array}{cccc}\text{Production}& \text{Production}& \text{Production}& \text{Opportunity}\\ \text{Possibilities}& \text{of Goods-X}& \text{of Goods-Y}& \text{Cost of}\\ & \text{(Units)}& \text{(Units)}& \text{producing}\\ & & & \text{an}\\ & & & \text{additional}\\ & & & \text{unit of}\\ & & & \text{Goods-X}\\ A& 0& 20& -\\ B& 1& 18& 2\\ C& 2& 15& 3\\ D& 3& 11& 4\end{array}$

The table shows that at point B, production of an additional unit of good X leads to a reduction of good Y by 2 units. Likewise, at point D, opportunity cost of an additional unit of good X is estimated to be 4 units of good Y. At point C, another unit of good X, leads to a higher opportunity cost of 3 units of good Y. Likewise, at point D, opportunity cost of an additional unit of good X is estimated to be 4 units of good Y.