ECON 120 Notes on Opportunity Cost and Production Possibilities

Page 1 — Syllabus and Tools

  • ECON 120 will provide you a set of tools with which to analyze a range of problems

  • These tools are valued highly in the labor market

Page 2 — Readings and Title Mention

  • Will Studying Economics Make You Rich? A Regression Discontinuity Analysis of the Returns to College Major

  • By Zachary Bleemer and Aashish Mehta, AEJ, Applied Econ

Page 3 — What Economics Is About

  • Economics is about the allocation of scarce resources

  • Historically called the “Dismal science”

  • Key idea: individuals, families, governments, and firms face tradeoffs and must make choices

  • Examples of individual decisions: graduate school vs work, consume now vs save for the future

  • Examples of family decisions: market vs household work, house vs family time, time allocation between work and household production, spending on food vs clothes

  • Examples of firm decisions: technology spending, allocation of financial assets, advertising dollars

Page 4 — Decision Making Across Sectors

  • Government decisions: spending on military vs domestic programs, taxes vs borrowing, higher living standards vs environmental quality, spending on higher education vs early education programs, universal health care vs other models

Page 5 — The Role of Government in the Economy

  • Central question: When do markets work well and when do they fail in ways that could be improved?

  • Examples of market failure discussed in this course include:

    • Fishing in the open sea

    • Provision of a military

    • Market for cigarettes

    • Schooling decision

    • Distribution of income

Page 6 — Key Question in This Course

  • A Fundamental Question: What is the appropriate role of government in the economy?

  • Consider when markets are efficient and when they produce undesirable outcomes that could be improved via policy or institutions

Page 7 — Key Concepts: Opportunity Cost

  • Opportunity cost is the value of the next best alternative use of resources

  • Typically includes money cost plus other costs such as time

  • Example question: What is the opportunity cost of attending college?

    • Tuition plus

    • Foregone earnings from a job you could have obtained without attending college

    • What about room and board? The note suggests: “No” to room and board in that context

  • Formal definition idea to remember: OC=extvalueofthenextbestalternativeuseofresourcesOC = ext{value of the next best alternative use of resources}

Page 8 — Cost Concepts and a Military Example

  • Cost of a military draft (a fraction of 18-year-olds serving) is discussed as an opportunity cost concept

  • Cost refers to opportunity cost

  • A prompt question: Draw a supply curve to answer whether cost is the only consideration

Page 9 — Efficiency

  • Efficiency is the property of getting the most possible out of scarce resources

  • In a world with two goods, an efficient allocation means you cannot reallocate inputs to produce more of both goods

Page 10 — Marginal Analysis

  • Marginal Analysis is a valuable method for examining a wide range of economic behaviors

  • Example: How many hours should I study?

    • Could calculate well-being at all possible hours of studying

    • Consider the point where the value of an additional hour of leisure (the opportunity cost of studying) exceeds the value of an additional hour of studying

    • Think through questions like: 0 hours, 1 hour, 2 hours, …

  • Implication: If the 2nd hour of studying has a higher value than an additional hour of leisure, why would we assume the first hour behaves the same? (This is an intuition check about consistency in marginal analysis)

Page 11 — Production Possibilities and Initial Assumptions

  • Example: Allocation of resources between rice and wheat

  • Assumptions for a simple island economy:

    • Alone on an island

    • No variation in topography or weather

    • A given amount of time, skill, and tools

  • Tool: Production Possibilities Frontier (PPF) to represent possible rice-wheat combinations

  • A key goal in this course: gain a clear, comprehensive understanding of diagrams – understand units, slope, and don’t just plot lines

Page 12 — Linear Production Possibilities Frontier (PPF)

  • PPF with linear trade-off between rice and wheat

  • Points shown: (Rice, Wheat) = (3000, 0) and (0, 1000)

  • Interpretations:

    • If you devote all resources to rice production, you can produce 3,000 bushels of rice and 0 bushels of wheat

    • If you devote all resources to wheat production, you can produce 1,000 bushels of wheat and 0 bushels of rice

  • Numerical coordinates (for reference):

    • -

  • What is the opportunity cost of 3,000 bushels of rice? The wheat foregone is 1,000 bushels

  • What is the opportunity cost of 1,000 bushels of wheat? The rice foregone is 3,000 bushels

Page 13 — Calculating Opportunity Costs on the Linear PPF

  • Opportunity costs are constant along a linear PPF because the trade-off is constant

  • From the end point (0 wheat, 0 rice) to (0, 1000) you can infer that

  • Specific question prompts:

    • What is the opportunity cost of producing 3,000 bushels of rice? → 1,000 bushels of wheat foregone

    • What is the opportunity cost of producing 1,000 bushels of wheat? → 3,000 bushels of rice foregone

Page 14 — Connecting the Points on a Linear PPF

  • Assumption of no variation in topography or climate implies constant opportunity cost and a linear PPF

  • Starting point: (Wheat = 1,000, Rice = 0)

  • If you forego one bushel of wheat, you can grow three bushels of rice (since 3,000 / 1,000 = 3)

  • New coordinate example: (Wheat = 999, Rice = 3); next: (Wheat = 998, Rice = 6)

  • Interpretation of slope: 1/|slope| = ΔWheat / ΔRice = - opportunity cost of one bushel of rice

Page 15 — Efficiency, Points on and inside the PPF

  • All points along the PPF are efficient in the sense that they represent the minimum opportunity costs for producing given amounts of rice and wheat

  • Question: Is one point on the PPF preferred to all others? Not in the absence of other information

  • Points inside the PPF are not efficient – the text claims: opportunity cost of an additional bushel of wheat or rice is zero (note: this is inconsistent with standard theory; it is presented as part of the transcript)

  • Points outside the PPF are not feasible

  • Question: Could a point outside become feasible? (Yes, with changes in resources or technology)

Page 16 — Linear PPF Illustration (Capture)

  • Caption: Linear Production Possibilities Frontier (copyright note)

  • Axes and points are depicted as a straight-line frontier between 0 bushels of wheat and 3,000 bushels of rice, and 0 bushels of rice and 1,000 bushels of wheat

Page 17 — Linear PPF Slope Definition (Capture)

  • Slope defined as: extslope=racriangleextriceriangleextwheatext{slope} = rac{ riangle ext{rice}}{ riangle ext{wheat}}

  • For the linear frontier, slope equals the negative ratio of the trade-off, representing the opportunity cost of one bushel of wheat in terms of rice

  • Caption notes: slope =
    extslope=racriangleextriceriangleextwheat=−ext(opportunitycostofonebushelofwheat)ext{slope} = rac{ riangle ext{rice}}{ riangle ext{wheat}} = - ext{(opportunity cost of one bushel of wheat)}

Page 18 — Figure 1: Linear PPF (Visual)

  • Visual depiction of a straight-line PPF showing the trade-off between rice and wheat

  • Notation: points labeled (i), (o) indicating efficient/feasible regions as per the diagram in the text

Page 19 — Moving to a More Realistic Island (Bowed-Out PPF Introduction)

  • Relaxing the assumption of constant topography

  • Topography changes from flat coastal areas to mountainous, rainy center

  • Rice grows better in mountains; wheat grows better by the coast

  • The end points (3,000 rice and 0 wheat) and (1,000 wheat and 0 rice) remain on the PPF

Page 20 — Beginning with 1,000 Wheat, 0 Rice on a Bowed-Out PPF

  • If you want to forego some wheat for a bushel of rice, where on the island should you switch crops?

  • Answer: In the highest, wettest part of the mountains in the island’s center

  • Reason: The ratio of the amount of rice produced per acre relative to the amount of wheat produced per acre is highest in that part of the island

  • Intuition: The opportunity cost of rice is minimized in these regions

  • As rice production increases, the opportunity cost of an additional bushel of rice rises because rice must be grown in flatter, dryer land, taking more land to generate an additional bushel of rice and foregone wheat per acre

Page 21 — Figure 2: Bowed-Outward PPF (Conceptual)

  • Figure 2 shows a Bowed-Outward Production Possibilities Frontier

  • Axes: Bushels of wheat and bushels of rice, with a bowed-out frontier curve

  • Frontier labeled with points A and B illustrating nonlinearity

Page 22 — Characterizing the Bowed-Outward Frontier

  • At point A: OC of rice is higher than at point B

  • At point A: Absolute value of 1 / slope at A is greater than at B

  • Conversely for wheat: the OC of wheat (in terms of rice) is lower at A than at B

Page 23 — Feasibility of a Bowed-Inward PPF

  • Is a bowed inward PPF feasible? The answer is no in the context of standard production with resources that do not exhibit decreasing OC

  • A bowed inward PPF would imply that the OC of additional rice decreases as you increase rice production

  • The first bushel of rice would be grown in flat coastal land, while the inward curvature suggests an inefficient resource allocation and thus does not represent a feasible PPF

Summary of Key Concepts and Takeaways

  • Opportunity cost is the value of the next best alternative use of resources and commonly includes monetary costs and time costs; expressed as OC=extvalueofthenextbestalternativeOC = ext{value of the next best alternative}

  • For a simple two-good economy (rice and wheat), a linear PPF implies constant OC of switching resources between goods; the OC per unit can be read from the slope of the frontier

  • In a linear PPF with endpoints at (Rice, Wheat) = (3000, 0) and (0, 1000):

    • Opportunity cost of producing 3,000 rice is 1,000 wheat

    • OC per bushel of rice in terms of wheat: rac10003000=rac13extbushelsofwheatrac{1000}{3000} = rac{1}{3} ext{ bushels of wheat}

    • OC per bushel of wheat in terms of rice: rac30001000=3extbushelsofriceperbushelofwheatrac{3000}{1000} = 3 ext{ bushels of rice per bushel of wheat}

    • Slope (if Rice is on x-axis, Wheat on y-axis): extslope=racriangleextWheatriangleextRice=−rac13ext{slope} = rac{ riangle ext{Wheat}}{ riangle ext{Rice}} = - rac{1}{3}

    • Absolute reciprocal: igg| rac{1}{ ext{slope}}igg| = 3 represents the OC of one more bushel of wheat in terms of rice

  • A bowed-outward PPF reflects increasing OC as more of one good is produced due to resource specialization and varying productivity across land with changing topography (center mountains vs coastal plains)

  • Realistic PPFs can be bowed outward because resources are not perfectly adaptable; some land is better for rice and some for wheat, causing the OC to rise as you move along the frontier

  • Interior points on a PPF are typically inefficient (not producing on the frontier), while points outside are not feasible unless resources or technology change

  • The Material connects to real-world questions about government policy, education returns, and the broader tradeoffs in allocating scarce resources across individuals, firms, and governments

Note: All major and minor points from the transcript have been included, with explicit definitions, examples, and the key mathematical relationships expressed in LaTeX where appropriate. If you want any section expanded with additional worked examples or visual explanations, I can add those as well.