Ignou Semster 3 Assignments

Topics: Economics, Microeconomics, Supply and demand Pages: 10 (3112 words) Published: April 29, 2013
1. “The Opportunity cost of a product is the return that can be had from the next best alternative use”. Explain this statement using production possibility curve.

The opportunity cost is the cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits we could have received by taking an alternative action.

Opportunity Cost and the PPC

The production possibilities curve illustrated above has two significant characteristics:

1.The PPC slopes downward and to the right. This represents the OPPORTUNITY COST of increasing the output of one good at the expense of the second good. An increase in food production requires a reduction in the production of clothing. The slope of the PPC is negative at all points on the curve. Opportunity cost is measured by the slope of the PPC (the change in along y-axis divided by the change along the x-axis). As production of food increases, production of clothing declines and vice versa.

2.The PPC is "bowed outward" (concave) from the origin. This represents INCREASING OPPORTUNITY COST. For example, increasing food production from 0 units to 10 units requires only a small reduction in clothing production. A further increase from 10 to 20 requires a larger sacrifice. Finally increasing from 40 to 50 requires the largest sacrifice. The opportunity cost of producing more food increases as we move to the right in the graph. The slope of the PPC becomes more negative as we move from left to right on the curve.

INCREASING OPPORTUNITY COST - As more scarce resources are used to increase production of one good or service, production of another good or service falls by larger and larger amounts.

Why are there increasing opportunity costs? To produce more food, resources employed in clothing production must be transferred to food production. The first resources transferred from clothing to food production will likely be those that are best suited for food production. For example, the most fertile land is first transferred from raising sheep to growing food. As more resources are transferred those resources are progressively less well suited to food production. Increasing opportunity costs is a reflection of the specialized characteristics of resources. Resources are not perfectly adaptable to alternative uses.

A PPC shows it takes the form of the curve on the right. For an economy to increase the quantity of one good produced, production of the other good must be sacrificed. Here, butter production must be sacrificed in order to produce more guns. PPFs represent how much of the latter must be sacrificed for a given increase in production of the former.[1]

Such a two-good world is a theoretical simplification, due to the difficulty of graphical analysis of multiple goods. If we are interested in one good, a composite score of the other goods can be generated using different techniques.[2][3] Furthermore, the production model can be generalised using higher-dimensional techniques such as Principal Component Analysis (PCA) and others


The diagram showing the production possibilities frontier (PPF) curve for producing "Gun" and "butter". Point "A" lies below the curve, denoting underutilized production capacity. Points "B", "C", and "D" lie on the curve, denoting efficient utilization of production. Point "X" lies outside the curve, representing an impossible output for existing capital and/or technology. Shift of PPF to point "X", will change if there improvement of factors of production (ie Capital and/or technology).

In this Diagram the production possibility curve reflecting they different combinations of goods , which an economy can produce ,given its state of technology and total resources .It illustrate the menu of choices open to the economy. For example the economy can produce only two goods ,butter and guns. The...
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