Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.

PART I Introduction

Chapter 2 of 36 Thinking Like An Economist

Section 6 of 13

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Figure 2 here

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Restated from Chapter 1, the ten principles of Economics:

1: people face trade-offs

2: the cost of something is what you give up to get it

3: rational people think at the margin

4: people respond to incentives

5: trade can make everyone better off

6: markets are usually a good way to organize economic activity

7: governments can sometimes improve market outcomes

8: a country's standard of living depends on its ability to produce goods and services

9: prices rise when the government issues too much money

10: society faces a short-run trade-off between inflation and unemployment

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One of the Ten Principles, #1: people face trade-offs.

Per Figure 2, when the economy moves from point A to point B society produces 100 more cars at the expense of producing 200 fewer computers.

This trade-off shows another of the Ten Principles, #2: the cost of something is what you give up to get it.

This cost is called the opportunity cost.

The production possibilities frontier shows the opportunity cost of one good measured in terms of the other good.

When society moves from point A to point B, it gives up 200 computers to get 100 additional cars.

Here the opportunity cost of each car is two computers.

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The opportunity cost of a car in terms of the number of computers, is not constant, not a straight line in this economy.

Rather it depends on how many cars and computers the economy is currently producing.

This is reflected in the bowed shape of the Figure 2 production possibilities frontier.

The opportunity cost of a car is highest when the economy is producing many cars and fewer computers such as at point E, where the frontier is steep.

At this point, to move from 950 cars to 1000 cars, must give up 300 computers.

This is a 50:300 = 1:6 trade-off ratio, for each additional 1 car must give up 6 computers.

The opportunity cost of a car is lowest when the economy is producing few cars and many computers, such as at point F, where the frontier is flat.

Here, to move from 100 cars to 300 cars, must give up 200 computers, 1:1, for each additional 1 car must give up 1 computer.

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Economists believe production possibilities frontiers usually have a bowed shape.

When the economy is using most of its resources to make computers, point F some resources best suited to car production, such as workers more naturally talented for auto production, are being used to make computers.

Because these workers aren't as good at making computers, the economy won't have to lose much computer production to increase car production by one unit.

So, at point F the opportunity cost of a car in terms of computers is small, and the frontier is relatively flat.

Conversely, when the economy is using most of its resources to make cars, point E, the resources best suited to making cars are already in the car industry.

So, the opportunity cost, in terms of number of computers made, of a car is high at point E and the frontier is steep.

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opportunity cost

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