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Opportunity Cost.When one makes economic decisions, it is because of limited resources. Alternatives must be considered. People make such decisions based on expecting greater benefits from one alternative than another. There is an opportunity cost involved in the choice. Opportunity cost is the benefit forgone from the best alternative that is not selected: Individuals give up an opportunity to use or enjoy something in order to select something else.
Opportunity costs can’t always be measured, because it might be satisfaction that is lost. At other times, however, opportunity cost can be measured. Here are examples of each. Perhaps a student is studying hard for a final examination in a difficult course because a good exam score is critical to achieve the desired grade. Friends call to invite the student out for the evening. The alternatives are to study or to have fun. Being wise, the student selects studying instead of going out. It is difficult to measure the opportunity cost of having fun with friends. In the second example, the same studying student is asked to help someone clean a garage. If the person offers to pay the student $50 to clean the garage and the student chooses to study, the opportunity cost is easily measured at $50. In both these examples, opportunity cost is directly related to what was given up, not any other benefits that might result from the decision.
Circumstances also play a role in opportunity cost. Sometimes people are forced into a decision because of circumstances and the results may not always be optimal. For example, if someone is planning to relocate to a new city to start a new job and wants to sell a house before the move in order to be able to purchase a new house in the new location, the person may sell the house for less than the market price in order to complete the process. The opportunity cost is the value of what was given up in order to be able to purchase a new home. Every time a choice is made, opportunity costs are assumed.
Production.Another economic choice that must be made is related to production. This is illustrated in Figure 1. All four of the decisions must be made: What goods will be produced? How will production occur? How much should be produced? Who will be the recipients? All are decisions that influence production efficiency.
Efficiency is the primary element in deciding what to produce and how to go about the production process. Efficiency is producing with the least amount of expense, effort, and waste, but not without cost. If you take something away from a person to satisfy another person, one will be less happy and the other will be happier. If a way can be found to make one person happier without making the other person less happy, this would be efficient.
An example of economic efficiency might be the following. Assume someone owns a car and a friend doesn’t own a car but does drive. The friend needs transportation regularly for a week. It happens to be a time when the car owner will be away on a business trip and therefore won’t be using the car. It makes no sense for the friend to buy a car to use for such a short period of time, so the owner loans the friend the car for that week. Economic efficiency has occurred in this situation. If the car owner had not loaned the car to the friend, there would have been waste because the friend would have had to buy or rent a car. It is wasteful to fail to take advantage of opportunities in which there is no loss of satisfaction to either party.
Production efficiency is a situation in which it is not possible to produce any more units of a good without giving up the opportunity to produce another good unless a change occurs in available productive resources. If a farmer is growing wheat to be sold for the production of bread, there is a point at which adding additional fertilizer to the soil would do no good. The way to increase the wheat production is to find different resources to make the crop better, such as irrigating the land to provide more moisture.
In the above example, it was suggested that different or additional resources might be used to increase production. This is necessary only after efficiency has been achieved. Additional resources would have to come from land, labour, capital, or entrepreneurship. It is most common that capital will be used most often to increase production.
Capital is productive input that is increased by people. This is known as investment. Investment involves giving up what might presently be consumed in favour of producing something to consume in the future. If the farmer wants to increase wheat production in the future, something will have to be given up now in order to increase the resources available for future production.
Increasing human capital is critical to increasing production. This does not mean that more people must be produced, but rather that the knowledge and skills of humans must be increased. This can happen because of improvements in technology and new ways of satisfying wants. This involves the entrepreneurial factor that was described previously – the human element that figures out ways to improve and expand the resources that already exist.
Product Distribution.Getting goods into the hands of those who want them involves many choices. The economic system must decide how to divide the products that are produced among the potential recipients. Sometimes products can be divided equally among recipients, but normally this is not the situation. It must then be determined how the division will take place. In a capitalistic economic system, distribution is often determined by wealth. If two people have the same wants, the person who can most afford something will be able to acquire it.
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