Remember, since you can only be in once place at a time, only the next best option is relevant in your decision making. One common fallacy when evaluating opportunity costs is considering all the different ways you could be spending your time. By continuing to read, you are forfeiting the opportunity of doing one of those things. Perhaps for the hour you spend reading, you could have made $11 working at a restaurant, scrolled through Facebook, or spent time with friends. Consider the opportunity cost of reading this textbook. The concept of “Opportunity Cost” is not just applicable when you are stranded on an island in fact, we face opportunity costs every day. While marginal opportunity cost is not always increasing, it is intuitive to think that the more pineapples you pick, the harder they will be to find, and therefore the more time you will have to give up to harvest 10 more.Īpplications Opportunity Cost At University This continues until there are no more crabs to give up. To produce the next ten pineapples, it costs two crabs, and the next ten costs four. Notice how the marginal cost changes as you harvest more pineapples. In this case, since you have to give up one crab to produce 10 pineapples, the marginal opportunity cost for one pineapple is 1/10 of a crab. This concept is called the Marginal Opportunity Cost of an action. This is an important concept even though our scarce resource is time, we can measure the cost of a good, in this case, pineapples, in terms of the foregone good, in this cases crabs. How many would have to be given up in order to obtain ten pineapples? In this example, only one. Notice that you can produce either all crabs, all pineapples, or a mix of the two.Īssume you choose to only catch crabs. The table is very logical – if you spend all your time catching crabs, you will have no pineapples. This scarcity limits the amount of total production.įigure 2.2a displays a table showing several different combinations of goods that can be harvested in a given week. Since there are only a certain number of hours in the day, time is a scarce resource. While this is an extreme example, it is reflective of a common problem in production. You are forced to make a decision on how to allocate the scarce resource of time. In other words, you face a trade-off: any time you spend harvesting pineapples is time that cannot be spent looking for crabs. On this island, there are only two foods: pineapples and crabs. You are stranded on a tropical island alone. For this model, imagine the following scenario: Model of Production If you were stranded on an island with only pineapples and crabs, how much of each would you produce? Would this change depending on how difficult each one was to harvest? (Credit: Pablo Garcia Saldaña/Unsplash)Īn economic model is only useful when we understand its underlying assumptions. By understanding these models, we can develop a mindset to understand the economic world. Economic models are the building blocks of most modern economic theory. Holding some information constant can help us understand a concept without being overwhelmed by a vast number of influencing factors. While one should remain aware of this, these models are still useful. Oftentimes in introductory Microeconomics, these models seem oversimplified because they hold certain variables constant. How can we navigate such complex economic issues to make normative judgments? The answer is economic models.Īn economic model is a simplified framework that is designed to illustrate complex processes. Many of these examples are macro issues that will impact our micro analysis. The weather can impact the production of goods, and politics can create tension between countries. A country’s interest rate influences the flow of financial capital its exchange rate encourages or discourages the purchase of goods and services. Think of all the different variables that can impact trade. (Credit: DarrenRD/ Wikimedia Commons/ CC-BY-SA-4.0) Although there are many unpredictable aspects to our world, economics develops a simplified framework to make analysis despite these unknowns. The devastation severely impacted the economy of Alberta, not to mention the lives of many of its habitats. The fires in Fort McMurray were a natural disaster that could not have been anticipated.
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