Next lesson. Current timeTotal duration Google Classroom Facebook Twitter. Video transcript What I want to do in this video is think about how the opportunity cost can change as we move from scenario to scenario. And this is going to be particular to this example, but it's a phenomenon that you will see in many economic scenarios. So let's say we're starting off in Scenario F. We are vegetarians. We are only getting berries. We are not spending any time going after rabbits. But now we're starting to, I guess, crave protein.
And we say, well, what is going to be the opportunity cost if I go for that extra rabbit? If I go for that extra rabbit, then what's going to happen? Well, I'm going to have to stay on my production possibilities frontier. And so I'm going to move to Scenario E. So if I go after that one extra rabbit, I'm going to give up 20 berries. So my opportunity cost in Scenario F, sitting in Scenario F, of going after that 1 rabbit is 20 berries.
Now let's keep going. What happens if I'm in Scenario E? I'm already, on average, eating 1 rabbit or finding 1 rabbit a day. And I want to go to 2 rabbits a day. What am I going to give up? Let me do that in that same color. What will I give up? Well, now I am going to give up 40 berries. This is interesting. Now let's say we're in Scenario D and we want even more rabbits. We're really starting to become carnivores now. Well, I'm going to give up 60 berries. If I'm able to get 3 rabbits, every day, on average then I'm only going to get berries now instead of And let's just keep going.
So if I want yet another rabbit every day, then I'm going to have to give up 80 berries. Despite this, Pareto efficiency is still an extremely useful concept. A point on a PPF is, by definition, productively efficient in that all of the economies resources are being fully employed, and their is no waste or unemployment. For it to be allocatively efficient it must satisfy consumer demand and consumer preferences. As will be seen later, allocative efficiency is more formally expressed as a level of output where the marginal benefit to the consumer or the last unit consumed equals the marginal cost of supply of that unit.
Clearly, not all combinations will satisfy this condition. In the example shown, a society may produce only meat or vegetables, but its population prefers a varied diet. Opportunity cost can be thought of in terms of how decisions to increase the production of an extra, marginal, unit of one good leads to a decrease in the production of another good. According to economic theory, successive increases in the production of one good will lead to an increasing sacrifice in terms of a reduction in the other good.
For example, as an economy tries to increase the production of good X , such as cameras, it must sacrifice more of the other good, Y, such as mobile phones. This explains why the PPF is concave to the origin, meaning its is bowed outwards. For example, if an economy initially produces at A, with 8m phones and 10m cameras to 20m , and then increases output of cameras by 10m, it must sacrifice 1m phones, and it moves to point B.
If it now wishes to increase output of cameras by a further 10m to 30m it must sacrifice 2m phones, rather than 1m, and it moves to point C; hence, opportunity cost increases the more a good is produced. The gradient of the PPF gets steeper as more cameras are produced, indicating a greater sacrifice in terms of mobile phones foregone.
Economic decisions are taken in a marginal way, which means that decisions to produce, or consume, are made one at a time.
For example, a typical consumer does not decide to drink four cans of cola at the beginning of each day, rather they make four individual decisions, one at a time. Similarly, a baker does not decide to produce 5, loaves of bread in a year, but decides each day or week what to produce. Economic decisions are marginal because conditions are constantly changing, and consumers and producers would be highly irrational if they did not consider this.
Hence, each production or consumption decision is assumed to be made one at a time so that changing conditions can be assessed. Go to: Economic growth. Stagflation is a combination of high inflation, high unemployment, and stagnant economic growth. Similarly, for Country B, the opportunity cost of producing both products is high because of the effort required to produce cars given its lack of steel.
An economy may be able to produce for itself all of the goods and services it needs to function using the PPF as a guide.
However, this may actually lead to an overall inefficient allocation of resources and hinder future growth when the benefits of trade are considered. Through specialization , a country can concentrate on the production of just a few things that it can do best, rather than trying to do everything on its own. Each country in our example can produce one of these products more efficiently at a lower cost than the other. We can say that Country A has a comparative advantage over Country B in the production of cars, and Country B has a comparative advantage over Country A in the production of cotton.
Or, both countries could decide to specialize in producing the goods for which they have a comparative advantage. Each can trade its specialized product to the other and both countries will be able to enjoy both products at a lower cost. Quality will improve, too, since each country is making what it makes best.
Determining how countries exchange goods produced by comparative advantage "the best for the best" is the backbone of international trade theory. This method of exchange via trade is considered an optimal allocation of resources. It means that national economies, in theory, will no longer be lacking anything that they need.
Like opportunity cost, specialization and comparative advantage also apply to the way in which individuals interact within an economy. At least in modern times, few people try to produce everything they consume. Sometimes a country or an individual can produce more than another country, even though countries both have the same amount of inputs.
For example, Country A may have a technological advantage that, with the same amount of inputs good land, steel, labor , enables the country to easily manufacture more of both cars and cotton than Country B.
A country that can produce more of both goods is said to have an absolute advantage. Better access to natural resources can give a country an absolute advantage, as can higher levels of education, skilled labor, and overall technological advancement.
It is not possible, however, for a country to have an absolute advantage in everything that must be produced. The curved shape reflects the law of diminishing returns. This law states that there comes a point where an added production factor has less of an impact. For example, adding additional resources toward the production process may initially result in fairly large gains.
However, these gains gradually lessen, thus producing the PPF's outward curved shape. A straight line occurs if the opportunity cost remains constant. In this scenario, the opportunity cost of producing two goods is projected as being equal regardless of where you are along the line. In reality, this scenario is uncommon and the PPF is more often shown as an outward bending curve. A variety of factors can shift a nation's PPF outward or inward. Macroeconomic factors , such as high unemployment or rising inflation, could cause an inward shift in the PPF.
On the other hand, the PPF could shift outward due to a number of factors. An increase in highly trained workers, improved technology, and greater access to capital to fund growth are examples of factors that could promote an outward PPF shift. Business Essentials. Your Privacy Rights. To change or withdraw your consent choices for Investopedia.
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Your Practice. Popular Courses. Economy Economics. Table of Contents Expand. Production Possibility Frontier. How the PPF Works.
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