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Section 2 Opportunity Cost

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Objectives

After studying this section you will be able to:

1. Describe why every decision involves trade-offs.
2. Explain the concept of opportunity cost.
3. Explain how people make decisions by thinking at the margin.

Section Focus

All human decisions involve tradeoffs. The next best alternative to any choice is called an opportunity cost. Decision-making grids can make it easier to identify the trade-offs and opportunity cost of a decision.

Key Terms

• trade-off
• guns or butter
• opportunity cost
• thinking at the margin

Several years ago, a few hotels in Washington, D.C., offered a special service to their guests. A popular art exhibit was in town, but the only way to get tickets was to wait in line for several hours. Many of the hotel's guests were unable or unwilling to do this. Instead, the hotels hired people to stand in line to purchase the $5 tickets. The hotels then sold the tickets to guests for $50 apiece. These guests spent money rather than time in order to get their exhibit tickets. Similarly, when we decide on one alternative, we gain one thing but lose something else.

Trade-Offs

Economists point out that all individuals, businesses, and large groups of people—even governments—make decisions that involve trade-offs. Trade-offs are all the alternatives that we give up whenever we choose one course of action over another.

What are some of the trade-offs of buying a car?

Individuals and Trade-Offs

Every decision we make involves tradeoffs. For example, if you choose to spend more time at work, you give up watching a movie or going to a baseball game. Choosing to play soccer might prevent you from working on the yearbook or having a part-time job.

Businesses and Trade-Offs

The decisions that businesspeople make about how to use land, labor, and capital resources also create trade-offs. Farmers who plant broccoli cannot use the same land at the same time to grow cauliflower. A manufacturer who decides to use all her equipment to build chairs eliminates the possibility of building tables or desks at that same time.

Society and Trade-Offs

Countries also make decisions that involve trade-offs. Economists simplify their explanations of the trade-offs countries face by using the example of guns or butter. In short, a country that decides to produce more military goods (“guns”) has fewer resources to devote to consumer goods (“butter”) and vice versa. (Remember, resources are limited!) The steel used to make a tank is no longer available for building the dairy equipment needed to make butter.

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