Why do opportunity costs increase with production

That is, if the production of product A increases then the production of product B will have to decrease. The Pareto Efficiency states that any point within the PPF curve is inefficient because the total output of commodities is below the output capacity.

Conversely, any point outside the PPF curve is impossible because it represents a mix of commodities that will require more resources to produce than are currently obtainable.

Therefore, in situations with limited resources, only the efficient commodity mixes are those lying along the PPF curve, with one commodity on the X-axis the other on the Y-axis. Consider a hypothetical world that has only two countries Country A and Country B and only two products cars and cotton. Suppose that Country A has very little fertile land and an abundance of steel. Country B has an abundance of fertile land but very little steel.

If Country A were to try to produce both cars and cotton, it would need to split its resources and put a great deal of effort into irrigating its land to grow cotton. That would mean it can produce fewer cars, which it is much more capable of doing. The opportunity cost of producing both cars and cotton is high for Country A. Similarly, for Country B, the opportunity cost of producing both products is high because of the effort required to produce cars given its lack of steel.

An economy may be able to produce for itself all of the goods and services it needs to function using the PPF as a guide. However, this may actually lead to an overall inefficient allocation of resources and hinder future growth when the benefits of trade are considered. Through specialization , a country can concentrate on the production of just a few things that it can do best, rather than trying to do everything on its own. Each country in our example can produce one of these products more efficiently at a lower cost than the other.

We can say that Country A has a comparative advantage over Country B in the production of cars, and Country B has a comparative advantage over Country A in the production of cotton. Or, both countries could decide to specialize in producing the goods for which they have a comparative advantage. Each can trade its specialized product to the other and both countries will be able to enjoy both products at a lower cost. Quality will improve, too, since each country is making what it makes best.

Determining how countries exchange goods produced by comparative advantage "the best for the best" is the backbone of international trade theory. This method of exchange via trade is considered an optimal allocation of resources. It means that national economies, in theory, will no longer be lacking anything that they need.

Like opportunity cost, specialization and comparative advantage also apply to the way in which individuals interact within an economy. At least in modern times, few people try to produce everything they consume. Sometimes a country or an individual can produce more than another country, even though countries both have the same amount of inputs.

For example, Country A may have a technological advantage that, with the same amount of inputs good land, steel, labor , enables the country to easily manufacture more of both cars and cotton than Country B.

A country that can produce more of both goods is said to have an absolute advantage. Better access to natural resources can give a country an absolute advantage, as can higher levels of education, skilled labor, and overall technological advancement. It is not possible, however, for a country to have an absolute advantage in everything that must be produced. The curved shape reflects the law of diminishing returns. This law states that there comes a point where an added production factor has less of an impact.

For example, adding additional resources toward the production process may initially result in fairly large gains. However, these gains gradually lessen, thus producing the PPF's outward curved shape. A straight line occurs if the opportunity cost remains constant. In this scenario, the opportunity cost of producing two goods is projected as being equal regardless of where you are along the line.

In reality, this scenario is uncommon and the PPF is more often shown as an outward bending curve. A variety of factors can shift a nation's PPF outward or inward. Macroeconomic factors , such as high unemployment or rising inflation, could cause an inward shift in the PPF. On the other hand, the PPF could shift outward due to a number of factors. An increase in highly trained workers, improved technology, and greater access to capital to fund growth are examples of factors that could promote an outward PPF shift.

Business Essentials. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data. As will be seen later, allocative efficiency is more formally expressed as a level of output where the marginal benefit to the consumer or the last unit consumed equals the marginal cost of supply of that unit.

Clearly, not all combinations will satisfy this condition. In the example shown, a society may produce only meat or vegetables, but its population prefers a varied diet. Opportunity cost can be thought of in terms of how decisions to increase the production of an extra, marginal, unit of one good leads to a decrease in the production of another good.

According to economic theory, successive increases in the production of one good will lead to an increasing sacrifice in terms of a reduction in the other good. For example, as an economy tries to increase the production of good X , such as cameras, it must sacrifice more of the other good, Y, such as mobile phones. This explains why the PPF is concave to the origin, meaning its is bowed outwards.

For example, if an economy initially produces at A, with 8m phones and 10m cameras to 20m , and then increases output of cameras by 10m, it must sacrifice 1m phones, and it moves to point B. If it now wishes to increase output of cameras by a further 10m to 30m it must sacrifice 2m phones, rather than 1m, and it moves to point C; hence, opportunity cost increases the more a good is produced.

The gradient of the PPF gets steeper as more cameras are produced, indicating a greater sacrifice in terms of mobile phones foregone. Economic decisions are taken in a marginal way, which means that decisions to produce, or consume, are made one at a time.

For example, a typical consumer does not decide to drink four cans of cola at the beginning of each day, rather they make four individual decisions, one at a time. Similarly, a baker does not decide to produce 5, loaves of bread in a year, but decides each day or week what to produce. Economic decisions are marginal because conditions are constantly changing, and consumers and producers would be highly irrational if they did not consider this. Hence, each production or consumption decision is assumed to be made one at a time so that changing conditions can be assessed.

Go to: Economic growth. Stagflation is a combination of high inflation, high unemployment, and stagnant economic growth. Because inflation isn't supposed to occur in a weak economy, stagflation is an unnatural situation.

Slow growth prevents inflation in a normal The laissez-faire economic theory centers on the restriction of government intervention in the economy. Well, now I am going to give up 40 berries. This is interesting. Now let's say we're in Scenario D and we want even more rabbits. We're really starting to become carnivores now. Well, I'm going to give up 60 berries. If I'm able to get 3 rabbits, every day, on average then I'm only going to get berries now instead of And let's just keep going.

So if I want yet another rabbit every day, then I'm going to have to give up 80 berries. And then finally, just to feel some sense of completion, if I become a complete carnivore and if I want to get on average, 5 rabbits a day, I'm going to have to give up another berries and go to not having any berries at all. And so you might see something interesting.

The more squirrels-- sorry, not squirrels although I guess they're similar-- the more rabbits that I'm going after, every time I try to go after another incremental rabbit I'm giving up more and more berries.

My opportunity cost is increasing. And so this phenomenon, it's not always the case but it's the case in this example, increasing opportunity cost. Increasing opportunity cost as we increase the number of rabbits we're going after. And you could do it the other way.

You could say, OK, as we increase-- especially if you did it on a unit basis, if you said every incremental berry or every incremental berries we're going after, but the numbers aren't as easy right over here-- you'll actually see something going the other way. But the question, an interesting question is, OK, Sal. You set up the numbers like this earlier two videos ago. But why would this make sense? Why is this idea of increasing opportunity cost showing up in a lot of different economic, and you can call this an economic model.

We have simplified our economic reality, the choices that we have to make, down to two variables the number of rabbits we have to go after or the number of berries. But why does this show up in economic models? And just to be clear, it does not show up in all of them.

But to think about our example, as a hunter gatherer, we started here in Scenario F. In Scenario F, we've decided to not pursue any rabbits. Even the slower, not so quick witted rabbit who maybe likes to hang out with you, next to you, and it likes to play with your spears or your bow and arrow-- you are not even going after that rabbit.

Instead you are choosing to spend all of your time on the berries. And not only are you getting, literally, the low hanging fruit, the easy berries, you're getting the berries that are further up the bush, the berries that you have to get cut by thorns to get, the berries that you have to climb trees to get.

So you're getting even hard to get berries and you're not going after even easy to get rabbits. But now all of a sudden if you say, well, you know, that rabbit who's been hanging out with me, he's been kind of asking for it. And so that was very easy to get.