Adam's Costs
The opportunity cost of something is what you sacrifice to get it. If Adam spends an hour clamming, he gives up the opportunity to spend that hour berry-picking. The opportunity cost of the additional clams Adam gets in an hour is the berries he could have if he'd spent the hour picking instead. The opportunity cost of a pound of clams for Adam is 2 pounds of berries.

Adam's Choice

Adam should choose the alternative that's best for him-- the one that gives him the most satisfaction. People make rational choices to maximize their satisfaction. By making small (incremental) changes, they find what's best by trial and error. To maximize satisfaction, apply the marginal principle: increase the level of an activity if the marginal (or incremental) benefit from the increase exceeds its marginal cost and reduce the level if the marginal cost exceeds the marginal benefit.

Adam's Decision

Adam should increase the time spent clamming so long as the satisfaction from the additional clams he gathers is greater than the marginal cost-- the satisfaction he could have had from 2 pounds of berries? If Adam has lots of berries and no clams, he's likely to be tired of always eating berries and would value some different food highly. As he has more clams, additional clams become less valuable. Adam is likely to choose some of both, such as 4 pounds of clams and 8 pounds of berries.

Eve is different

Eve has different skills and abilities than Adam. With more nimble fingers, she can pick 4 pounds of berries in an hour. If she used the hour clamming, she could dig 1 pound of clams. Eve's opportunity cost is different than Adam's. For each pound of clams, she must use on more hour clamming. An hour away from berry-picking costs her 4 pounds of berries. The opportuntiy cost of a pound of clams is higher for Eve (4) than for Adam (2).

National production possibilities

The same principles that apply to Adam also apply when we examine the production possibilites of a nation Imagine a small island economy which can grow either cotton (clothing) or tomatoes (food) If all the land in all 6 provinces is planted with tomatoes, then given the available labor force, capital, and technology for growing tomatoes, the maximum tomato production would be 21 tons. If the country wanted to grow some cotton for clothing instead, they could plant some land with cotton. Doing so, means not using the land for growing tomatoes.

Production Possibilities on the Island

If all the land on the island was planted with tomatoes except for the land in province Z, the output of tomatoes would be 15 tons. Province Z would produce 1 ton of cotton. If all the land on the island was planted with tomatoes except for province S, the output of tomatoes would be 20 tons. Province S would produce 1 ton of cotton. Which of these two alternatives is the most efficient use of land on the island?

The Island's Production Possibilities
Fill in the table below: Cotton 0  1    2     3     4     5     6   Tomatoes 21

Production Possibilities Curve

Shows the possible combinations an economy could produce in a given time period by using all its resources fully and efficiently. Points above or to the right of the curve are combinations of goods it is not possible to produce with the resources and technology now available. An economy operating inside its PPC has less than it could produce because some resources are unemployed or are used inefficently. Points on the curve represent maximum feasible output.

The Island's Opportunity Cost

The opporuntity cost of something is what you sacrifice to get it. The necessity of sacrifice (opportunity cost) makes the production possibilities curve slope down and to the right. To increase the quantity of the good measured on the horizontal axis, society must cut production of the good measured on the vertical axis. The slope of the production possibilities curve equals the opportunity cost. Calculate the opportunity cost of a ton of cotton at each point.

Increasing cost
The opportunity cost of a good increases as more of it is produced. Resources are not perfectly adaptable Some are better suited for the production of one good. Small quantities of a good are produced using resources best suited to the production of this good. Additional units require use of resources less suited to the production of this good and better for other things. The PPC is bowed out because the opportunity cost increases as more of a good is produced.

Where should the economy produce?
Isn't some point on the middle of the PPC best because the nation avoids high opportunity cost for either good? Not necessarily What's best depends on how people in that country value the different goods. People would want to incur the higher opportunity cost for additional units if what they get as a result is even mroe staisfying or beneficial than the alternative they sacrificed.

Current and Future Choices

The production possibilities curve shifts outward When the economy gains resources (the labor force grows, new resources are discovered) When technological change makes it possible to produce more with the same resources Wars and natural disasters can shift the PPC inward (to the left). If people sacrifice the production of consumer goods now in order to produce capital goods, the PPC will shift out more in the future and people will have more goods than they otherwise would. Future gains come at the cost of foregone consumption now.

Comparative Advantage
People have different opportunity costs of producing. Comparative advantage is the ability of a person to produce a good at a lower opportunity cost than another person can. Adam has a comparative advantage in the gathering of clams because his opportunity cost is 2 pounds of berries foregone while Eve's cost of a pound of clams is 4 pounds of berries.

Specialization

Specialization based on comparative advantage increases output. Before Specialization After Specialization Adam: 8 berries, 4 clams Adam:0 berries, 8 clams Eve: 20 berries, 3 clams Eve: 32 berries, 0 clams Total: 28 berries, 7 clams Total: 32 berries, 8 clams Output increases because people spend more time in their more productive activity and don't waste time shifting from one task to another. Also, over time they will acquire more experience and skill.

Adam and Eve Trade

Adam would be willing to trade a pound of clams to Eve as long as he gets at least 2 pounds of berries in return. Eve will trade up to 4 pounds of berries in return for 1 pound of clams. If they exchange 1 pound of clams for 3 pounds of berries, both are better off after trade. Adam trades 3 pounds of clams to Eve for 9 pounds of berries Adam now has 5 (not 4) clams and 9 (not 8) berries. Eve now has 21 (not 20) berries with her 3 pounds of clams.

Gains from Trade
Specialization requires trade if people are to have a variety of goods. Voluntary trade occurs if both parties gain from it. People won't trade if they expect the exchange to make them worse off. Trade based on comparative advantage allows both parties to gain by acquiring goods at lower opportunity cost.

International Trade

Different countries have different mixtures of resources. As a result, the opportunity cost of producing varies among countries. Trade based on comparative advantage will result in greater total output and gains for all countries (although not necessarily each individual within a country) Countries will export goods in which they have a comparative advantage (which they can produce at lower opportunity cost).