Introduction to Microeconomics

To get Delgado to play for them in 2009, the Mets must pay him a salary of $12 million. If they chose not to sign him, they would have had to pay him $4 million. So how much more did they have to pay, in order to get him to play for them? $12 million minus $4 million, or $8 million. That's the opportunity cost of having him play for them, because that is the extra money they gave up, by choosing to have him play. (see this, for example)

The firm here has three choices.

(i) They can go through with the original deal. That means they pay up the $15 million they still owe (the contract price of $20 million, minus the deposit of $5 million which they have already paid) and get the land.

(ii) They can walk away from the deal. That requires them to pay a penalty fee of $2 million, and they don't get the land.

(iii) They can walk away from the deal, and then renegotiate with the land owner. So walking away from the deal costs them $2 million in penalty fees, and then they can renengotiate a new deal, and get to buy the land for $8 million. So this choice costs them $10 million, and lets them get the land.


Choice (iii) is better for the firm than choice (i), since they get the land cheaper. So the firm should not make choice (i). The question they have to answer is whether they want choice (ii) or (iii). Choice (iii) gets them the land, but it costs them $8 million more than choice (ii) [$10 million instead of $2 million].

That means that the opportunity cost of the land to the firm is $8 million. Getting the land means giving up $8 million more than they would have to pay if they did not get the land.

If Alexander spends one more hour studying, he gets 2 more marks. But one hour more studying means one hour less of hockey practice, which results in 0.1 fewer goals. So 2 more marks in economics mean 0.1 fewer goals ; the opportunity cost of 1 more mark is 0.05 goals. Therefore the statement is incorrect that the opportunity cost of 1 mark is 0.2 goals ; it's 0.05 goals.

If the opportunity cost of 1 more mark is 0.05 goals, then the opportunity cost of 1 more goal is 20 marks. [The opportunity cost of goals in terms of marks is just 1 over the opportunity cost of marks in terms of goals.]

Since the number of marks gained per hour of studying, and the number of goals gained per hour of practice, are 20 and 0.1 respectively, regardless of how much he studies or practises, his PPF is a straight line. The slope of the line is -20, if marks are on the vertical axis and goals on the horizontal. The line connects the points (0,80) on the vertical axis [achieved if he spends all his time studying] with (4,0) on the horizontal axis [achieved if he spends all his time practising hockey].

An hour's work yields Evgeny more goals than Alexander (0.2 instead of 0.1),or better studying results (2.5 instead of 2). So Evgeny has an absolute advantage over Alexander ; that means that Evgeny's PPF is outside of Alexander's. If the economics mark is graphed on the vertical axis, and goals on the horizontal axis, then Alexander's PPF is a straight line, going from the point (0,80) on the vertical axis to (0,4) on the horizontal axis, with a slope of -20. Evgeny's PPF is a straight line going from the point (0,100) on the vertical axis to the point (0,8) on the horizontal axis, with a slope of -12.5. Evgeny's PPF is less steep than Alexander's, since 12.5 is smaller than 20.

The slopes of the PPFs imply that : the opportunity cost of 1 goal is 20 marks for Alexander, and 12.5 marks for Evgeny. Or the opportunity cost of one mark is 0.05 goals for Alexander and 0.08 goals for Evgeny. Evgeny has a comparative advantage in scoring goals and Alexander has a comparative advantage in studying.

When two different countries (or people) have straight-line PPFs, but the 2 PPFs differ in slope, then the overall (world) PPF will have the "kinked" shape of figure (d).

This note describes the "world" PPF in an example similar to the one in this question.

The diagram shows that the opportunity cost of computer chips in Australia is 2 units of wool, and that the oportunity cost of computer chips in Singapore is 1/2 unit of wool (since the slope of Australia's PPF is -2 and the slope of Singapore's PPF is -1/2).

Therefore, the opportunity cost of wool in Australia is 1/2 a computer chip, and the opportunity cost of wool in Singapore is 2 computer chips.

So Singapore does have a higher opportunity cost of wool production than Australia, and the Australia does have a comparative advantage in wool production -- which means that Singapore does have a comparative advantage in computer chip production.

Since Australia has a comparative advantage in wool production (and Singapore a comparative advantage in computer chip production), there can be gains from trade. Both countries may benefit from, for example a trade of 1 unit of Australian wool in exchange for 1 Singaporean computer chip.

The only false answer is "the opportunity cost of wool, measured in computer chips, is 2 in Australia". The second paragraph above shows that this opportunity cost is 1/2, not 2.

The location of the future PPF depends on (among other things) the stock of capital available in the future, which in turn depends on how much we invest in the present.

More investment means producing more capital goods. So producing more capital goods in the present will mean that we have more capital goods in the future (since capital goods are durable). More capital goods int he future means we can produce more in the future ; the future PPF shifts out. That makes us better off in the future, since we can produce more goods and services.

But there is a cost to producing more capital goods in the present. Our present PPF slopes down, indicating that we must reduce our production of consumption goods in the present, if we want to produce more capital goods. The cost of more investment in the present is less consumption in the present, which means that producing more capital goods int he future makes us worse off in the present (as we consume less), but enables us to be better off in the future (as the future PPF is shifted out).

The figure shows that the equation for Australia's PPF can be written W=60-2C, if W is Australia's wool production and C is Australia's chip production. The equation of Singapore's PPF can be written w=40-c/2, where w is Singapore's wool production and c is Singapore's chip production.

The production plan (C,W)=(10,40) is on Australia's PPF, and the production plan (c,w)=(80,0) is on Singapore's PPF. So it is possible for Australia to produce 10 units of chips and 40 units of wool, and for Singapore to produce 80 units of chips while producing no wool. If Australia then trades 25 units of wool to Singapore in exchange for 25 units of wool, Australia is left with 35 units of chips and 15 units of wool, while Singapore is left with 55 units of chips and 25 units of wool.

It is possible for Australia to produce (C,W)=(25,10) and for Singapore to produce (c,w)=(10,35). But then total chip production in the two countries is only 35, not enough to achieve the proposed consumption plan (of Australia consuming 35 chips and Singapore consuming 55 chips).

The production plan (W,C) = (40,10) is not possible for Australia : it's outside Australia's PPF. And the production plan (c,w) = (80,25) is ouside Singapore's PPF.

Similarly, the production plan (c,w) = (80,25) is outside Singapore's PPF, and therefore is not feasible.

(Oops)..it turns out that there are 2 false statements here (both got full marks).

If we know that Canadian workers can produce more cars per hour than Mexican workers, and more shirts per hour than Mexican workers, we know that Canada has an absolute advantage in production over Mexico. We do not know which country has a comparative advantage in car production (or in shirt production), unless we find out how the ratio of shirts produced per hour to cars produced per hour differs between Canada and Mexico.

But if Canada does have a comparative advantage in production of cars, compared with Mexico, then there will be gains from trade if Canada trades cars to Mexico in exchange for shirts. And Canada having a comparative advantage in car production is exactly the same thing as Mexico having a comparative advantage in shirt production.

Canada will have a comparative advantage in car production if (and only if), the ratio of cars produced per hour over shirts produced per hour is higher in Canada than it is in Mexico.

And the opportunity cost of cars in Canada is the number of shirts produced per hour (in Canada) divided by the number of cars produced per hour.

So it is backwards to say that a higher opportunity cost of cars means a comparative advantage.

One wrong statement is the statement that Canada will have a comparative advantage in car production if the opportunity cost of cars in higher in Canada. Canada will have a comparative advantage in car production only if we have a lower opportunity cost of car production.

But it is also backwards to say that a country should import the good in which it has a comparative advantage. If Canada has a comparative advantage over Mexico in car production, then Canada should import shirts from Mexico, and export cars to Mexico.

Suppose that originally a worker takes 2 hours to publish a book, and 2 hours to bake a cake. Then the original PPF will be a straight line, with slope -1, connecting the point (0,20) on the vertical axis with (20,0) on the horizontal axis, if the worker has 40 hours to split between book publishing and cake baking --- when we have books published on the horizontal axis, and cakes baked on the vertical.

If technological innovation lowers the number of hours it takes to publish a book from 2 to 1, then the new, shifted PPF is a line connecting (0,20) with (40,0).

The new PPF has been shifted out, but it has become less steep. Its slope has changed from -1 to -1/2.

The vertical intercept (with cake measured on the vertical) has not changed : we still can produce only 20 cakes a week if we produce nothing but cakes.

The only true statement is that the opportunity cost of a cake (in terms of books) has increased. before, the opportunity cost of 1 cake was 1 book. After the technological innovation, the opportunity cost of a cake has increased to 2 books : baking 1 more cake means having the worker spend one more hour on cake baking, which means 1 less hour on book publishing, which means 2 fewer books.