Increasing Opportunity Cost: What Is The Law Of Increasing Opportunity Cost?

Increasing Opportunity Cost: What Is The Law Of Increasing Opportunity Cost?
Increasing Opportunity Cost: What Is The Law Of Increasing Opportunity Cost?

The law of increasing opportunity cost states that whenever the same resource allocation decision is made, the opportunity cost will increase.

Increasing opportunity cost is important in business and economics because it describes the danger of a complete shift into non-production. 

There are constant opportunity costs because decisions will always be made about how best to allocate limited resources.  Consistently following the same decision, or moving more extreme toward it, will increase opportunity costs.

What Is Opportunity Cost?

This is sometimes called forgone production, meaning that in order to choose one strategy or method of producing a good, resources must be diverted from producing other goods. 

Opportunity costs are representative of what could be gained by using those resources in a different way, and how that use compares with the benefits ultimately generated by the chosen option.

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How Does Opportunity Cost Work?

Opportunity cost exists even when you don’t spend money.  Let’s say you own a store.  If you assign an employee to tidy up the warehouse instead of helping customers, it could cost you several sales because some customers will not be helped and will leave without buying anything. 

On the other hand, if you put it on the sales floor and the warehouse is cluttered, you may lose other sales because your employees can’t find the product that customers want to buy.  Any option has an opportunity cost.

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What Is The Law Of Increasing Opportunity Cost?

The law of increasing opportunity cost states that as a company continues to increase production, its opportunity cost increases.  In particular, if it increases the production of one product, the opportunity cost of producing the next unit increases. 

This happens because the manufacturer reallocates resources to produce that product.  However, using these resources for the original product was more profitable for the company.

Every business tries to use its resources as efficiently as possible, that is, effectively.  None of us have unlimited resources.  So it is very important that we make the right choices about what we have.

Our opportunity costs influence our decisions, say economists. Every time we direct more of our company’s resources in a certain direction, we face the law of increasing opportunity costs.

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How Does The Law Of Increasing Opportunity Cost Work?

The law of increasing opportunity cost is a concept often used in business and economics circles.  Essentially, this law states that as additional units of a good are produced, the opportunity costs associated with that production will also increase. 

Understanding this phenomenon can help businesses determine whether the choice to increase production is worth the effort, or whether increasing opportunity costs mean that the benefits are reduced enough to merit maintaining production at a lower level.

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Increasing Opportunity Cost PPC

A production possibilities curve (PPC) is a model that captures the scarcity and opportunity costs of a choice when faced with the possibility of producing two goods or services. 

Points inside the checkpoint are ineffective, checkpoints are effective, and points outside the checkpoint are unreachable. 

The opportunity cost of moving from one efficient combination of production to another efficient combination of production is how much of one good is given up to get more of the other.

The PPC form also gives us information about the technology of production (in other words, how resources are combined to produce these goods).  The curved shape of the PPC in Figure 111 indicates rising opportunity costs of production.

We can also use the PPC model to illustrate the economic growth represented by the PPC shift.  Figure 222 illustrates an agent that experienced economic growth. 

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Increasing Opportunity Cost PPF

Although the production possibilities frontier—PPF—is a simple economic model, it is a great tool for illustrating some very important economic lessons: A frontier illustrates scarcity because it shows the limits of how much can be produced with given resources. 

Every time you move from one point on the line to another, there is opportunity cost, which is what you have to give up to get something else.  Points inside the boundary indicate unused resources. 

In turn, the movement from the point of underemployment to the border indicates economic expansion.  When the border line itself moves, so does economic growth. 

And finally, the curved line of the frontier illustrates the law of increasing opportunity costs, which means that an increase in the production of one good leads to an increase in the loss of another good, because resources are not suitable for all tasks.

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What Are The Benefits Of Increasing Opportunity Cost In Business?

Opportunity cost and the law of increasing opportunity cost are illustrated by the production possibilities frontier (PPF) or production possibilities curve (never a straight line). 

This graph considers the factors of production (and assumes full employment), showing the ideal output level of two products competing for the same resources.

Businesses try to follow the arc of the curve on this graph, realizing that too far away from the plotted points indicates a misallocation of resources that will lead to a suboptimal economic outcome.

It is important to note that the PPF is theoretical and that no actual economic decision is made at maximum production efficiency and therefore maximum output cannot be assumed. 

This means that real variables such as the production costs of producing goods, the market value of specific consumer goods, and the United States’ international trade in capital goods and trade gains.

The rising cost principle also applies to personal finance, where people make economic decisions motivated by self-interest to ensure personal profitability. 

When making certain investment decisions compared to others, opportunity costs will increase: the marginal profit from a marginal increase in investment can be observed using marginal analysis; these revenues are usually governed by the law of increasing opportunity costs.

Conclusion

One way to understand how the law of increasing opportunity cost works is to consider a farmer deciding how to allocate farmland to grow two crops.  Instead of dividing the available land equally between the two, the farmer decides to plant 70% of the land to corn and keep the rest to soybeans. 

Although corn production increases due to the allocation of additional resources to this effort, it may increase the cost of producing soybeans on reduced land due to reduced returns from an enterprise that includes a number of fixed costs. 

At this point, the farmer will need to determine whether the benefits of growing more corn offset the increased costs of growing fewer soybeans, and then adjust the allocation of resources to obtain the most desirable outcome.

Increasing Opportunity Cost FAQs

What Is The Meaning Of PPC Production Possibilities Curve?

A production possibilities curve is a graphical representation of the alternative combinations of goods and services that an economy can produce.  This illustrates the production possibilities model.  In drawing the production possibilities curve, we will assume that the economy can produce only two goods and that the number of factors of production and technologies available to the economy are fixed.

What Does It Mean When The PPF Is A Straight Line?

A straight line occurs if opportunity costs remain constant.  In this scenario, the opportunity costs of producing the two goods are projected to be equal regardless of where you are along the line.  In reality, this scenario is unusual, and the PPF is more often displayed as a curve that curves outward.

Why Is PPF Important To An Economy?

An economy can produce all the goods and services it needs to function, using the PPF as a reference.  However, this may actually lead to an overall inefficient allocation of resources and hinder future growth when the benefits of trade are taken into account.

Thanks to specialization, a country can focus on producing just a few things it can do best, instead of trying to do everything on its own.

References

  • marketbusinessnews.com – Increasing Opportunity Cost – Definition And Examples
  • masterclass.com – Learn About the Law of Increasing Opportunity Cost in Business: Definition and Examples

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