GED Social Studies Practice Test: Opportunity Cost

Who hasn’t dreamed of being in two places at once (say, your workplace and the killer concert at the arena)? Or buying the hot little sports car but still having a wad of cash in your pocket. Well, folks, sorry, but this isn’t possible. Life is full of these either/or decisions but in economics we call them trade-offs — when one good or service is sacrificed for another. The cost of the trade-off (what is the value of the next-best alternative) is called opportunity cost.

Here’s a simple example: You have $100 in your pocket. A fixed-price dinner at the hottest local restaurant will cost $100. That same $100 will buy a shirt or skirt you’ve been craving. Well, you cannot afford both, so you have to make a decision. If you opt for the dinner, the opportunity cost (the value of the next-best thing) is the piece of clothing you’ve been eyeing. If you buy the shirt or skirt that you love, the opportunity cost is the delicious dinner at that restaurant.

One way of looking at trade-offs and opportunity costs is through a graphic known as a production possibilities curve. Of course, like most everything in economics, there are a few assumptions here. The first is that the amount of time, resources, and technology will remain the same over a given period of time (not always the case in real life). The other is that all of the resources involved are being used at maximum efficiency (that’s also a big assumption). But let’s take a look:

econ pic 2

The XYZ Company wants to produce as many consumer goods as possible (and therefore make as much money as it can). But this is simply not possible. If it spends all of the natural, human, and capital resources that it has making to make electric irons, then it can’t produce any sewing machines (Point A). If it spends all of its resources making sewing machines, then it cannot produce any irons (Point E). Points B, C, and D show the combinations of production possibilities. The opportunity cost of producing a certain number of irons is the number of sewing machines it can produce (and vice versa).

What could change this mix? Well, the XYZ company could expand and add more workers; it could utilize new technologies when they become available; or perhaps the company could build a bigger, more efficient factory. Nothing is static. On the other hand, if business drops, the cost of resources increases, or the company has to shed workers, the production possibilities curve would also change.


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