Opportunity cost is something that is foregone to choose one alternative over the other. Similarly, with scarce resources, when you decide to increase the production of certain goods over a specific limit, you need to compensate for it by producing lesser of the other goods. This Buzzle article talks about the ‘Law of Increasing Opportunity Cost’ in brief.
‘Opportunity’ refers to a chance to another alternative. When you choose one alternative, you lose the opportunity for another. There is an opportunity cost involved in every decision we take, be it economic or non-economic.
Imagine walking down the street and spotting two pretty dresses that you would wish to purchase. You wish to buy both of them, but you find that your budget doesn’t allow. So you decide to pick one of them, though it is a tough decision. This is an example where you had scarce resources (less money) because of which you had to sacrifice one dress for the other.
Similarly, every economy is huddled with the question of scarcity. The maximum and optimum allocation of resources is what every economy opts for. The Law of Increased Opportunity Costs deals with this scenario, i.e. when resources are limited and there is a decision to be made regarding the allocation of resources. Let’s understand this with the help of an example.
A company manufactures two products, ‘X’ and ‘Y’. The management of the company decides to increase the production of X. Let’s consider that the factors of production of this company are constant. To produce more of X, the company is not going to employ more resources (or factors of production). Thus, it has to forgo the benefits or profits from product Y, had it employed its resources in producing it.
We come across this concept in day-to-day life too. Say, you have 10 hours in hand and two subjects to study. Here, limited time is analogous to constant factors of production or limited resources. So, an hour spent in studying one subject is equal to the time lost in studying the other. That is the opportunity cost you have paid by foregoing the benefit from studying the other subject. Now, consider that you are not good at one subject, which is why you decide to give it more attention. This is a decision you have taken, considering the available resources and your needs. This is a real-life example of opportunity cost.
The second thing to be noted is that the decision does not depend only on the profit to be foregone. Suppose product Y makes lesser profits, and considering the opportunity costs, it is beneficial to produce more of the product X. However, it is not necessary that all the laborers are skilled enough to produce X. Their training costs involved might be much higher in comparison to the increased profits. Plus, there is an opportunity cost involved for the time invested in training them. Losses or sacrifices are not necessarily in monetary terms. It might mean time, electricity, usage of other resources, etc.
Production Possibility Curve
This curve indicates the opportunity cost of all the possible production capacities in detail. Consider that there is an economy producing either machines or apples. If it uses all its resources, there are various combinations available to produce both. However, with every increase in production of machines, the economy has to forgo producing a certain unit of apples. This indicates that after a certain limit, an increase in the production comes with an opportunity cost.
Wrong reallocation of resources may lead to an inefficiency in production. For example, too much privatization may lead to a rise in the goods that only the rich can afford. Imagine a nation where there are more diamonds than food grains! Obviously, this is a perfect example of a completely wrong allocation of resources for production. However, the modern economy does not always escape from this. Sometimes, that is the reason why resources end up being concentrated in the hands of a select few. We can see such examples in all economies. While there are some who struggle to feed themselves, there are some who enjoy the luxury of wasting food. Now, that’s something to ponder upon.