What are Opportunity Costs?

Hello, everyone. Welcome. My name's Annika Johnson.

I'm a senior lecturer in economics here at the University of Bristol.

And I'm here with Stefania Syrian,

and I'm also senior lecturer in economics at the Westin Bristol.

We're gonna be talking to you about the

extremely important topic of opportune titty costs.

This is so crucial to the way economists think

it drives the economic models that we look at.

It's really, really important.

And then later on,

we're going to take it to a related model called a production Possibility curve.

But I think we're going to really start by kind of nail down. What?

This idea of an opportunity cost is right?

Because, really, you know,

economics isn't just about the scarce or the allocation of scarce resources.

It's quite a dry definition of economics. In some sense, really.

Economics is getting to the heart of sort of the science of decision making.

So it's all those decisions we make, right?

So the little ones, you know, What time should I get up? What should I eat?

What time should I go to school? What type of job should I do? Should I get married?

Should I commit a crime all the way through

to those big society questions right about climate change,

inequality, inflation, energy crisis,

obesity and ageing populations.

All these things are big problems for

society that economists have something to say about

and a lot of it starts with the decisions we're making about our economy,

the decisions we're making in our own lives and behind all those decisions, I think,

is the idea of opportunity costs.

Would you agree? Yeah, I think so.

I think we can think of kind of some very simple

example some very simple decisions that we make every day.

So, for instance, when you buy a cup of coffee,

how what do you decide?

Am I going to have this cup of coffee or should I buy a croissant?

How much has discussed a cup of coffee going to cost me?

So it's a really simple transaction in some sense, right?

You go and say, Hi,

I'm gonna buy a cup of coffee in that cup of

coffee is going to cost me a couple of pounds,

maybe, maybe £2

maybe more by the time inflation has an effect. But if we say it's £2

and that's very much want to accountant might think about it, right,

because an accountant's job is to report on what

the costs were and what people actually paid out.

But economists might think about that £2 slightly differently.

Yes, because I can think of Okay, so if I'm going to spend the £2 on the coffee,

I spend the £2.

But on top of this, I've also foregone the cross on that I could have bought with £2.

So for me, the cost of coffee is not only

the amount of pounds that I pay for it,

but it's also the option or the alternative that I cannot buy

anymore now with the £2 that I spent on the coffee.

So there's lots of different things you could have thought.

You've picked one of them,

but there's probably another one that you could have picked or would have

liked to have picked that you can't because you bought the coffee.

So

this is a really simple example, but it is a day to day thing that we do, right.

Certainly from the consumer's point of view, we do this

every day in quite high high volumes I mean, as a student,

you also have to make a lot of decisions, right?

So you have to decide.

Am I going to spend the next hour studying,

or am I going to use this time to spend some time with my friends,

Maybe just go for a ride or go to the cinema?

So there's a lot of decisions that you have to to make.

So if you think if I decided to study for one hour the

cost of that is that what the activities that you could have done

otherwise in that specific type of amount of time there's

a real trade off and how you're using your time.

Do you use it to contribute towards your studying time?

Would you use it to contribute towards your leisure time? Exactly.

But it's not just consumers.

It's other parts of the economy to Producers also have to

make decisions about how to do stuff and what to do.

So a big decision, for example,

would be should you buy that new piece of

machinery and should you invest in So I think,

let's say you're in agriculture, right?

Should you invest in buying big new tractors and and, you know,

traditional farm equipment.

Or you could maybe instead,

use the money you've saved to invest in whole new types of agriculture.

Whether that's new products, um,

maybe like they're they're more vegan

products or more environmentally friendly products.

Um, really cool stuff like aero farming and all these new ideas that we're seeing.

The farmer has to make a decision as to which of

those routes to go down and which project to invest in.

If he decides to invest in the cool new aero farming or the cool new vegan products.

He can't then spend that same money on tractors. So there's

implicit in the decision he's made.

It made is not only what he's chosen also what he's not chosen exactly.

So the alternative that is missed on if you want.

So it's foregone, uh, that we were not able to get exactly.

And then it's the same for governments to governments have to make big decisions,

often with quite limited budgets, right.

And it's not just you know how to set

regulations that they have money they're going to spend,

you know, we've seen things recently,

like shortly before Boris Johnson stepped down.

He signed off £700 million towards a big infrastructure

projects to invest in a new nuclear power plant.

That's 700 million.

If you want the new nuclear power power plant, that's really important.

Don't get me wrong, but that's 700 million.

That's not going to then be spent somewhere else. Exactly.

So the opportunity costs are the alternatives that could have.

I mean, the other projects that could have been used to fund it with this money,

whether that's doing education differently or building new high speed railways,

building new housing, funding, the NHS differently, new hospitals, et cetera.

There there's so many things that could be done.

So there's a lot of words we just used their repeatedly,

and that's deliberate because they all get to this this

very short but very important definition of opportunity cost.

So it's the value of the next best alternative for God.

So everyone is important here is to underline that is the next best,

because we kept mentioning their various things that

you could have used your time doing or,

um,

money spent on various other things.

When you brought your coffee,

it wasn't just the coffee or the cost that you could have got.

There was also, I don't know, bananas or sandwiches. Muffins.

There's lots of different things,

but we're not talking about all of those together.

We're talking about the next best.

So if you hadn't brought the coffee, the thing that you would have bought Micro sent,

that is the thing that we're comparing.

And the opportunity cost is the difference in value

to you between those two things and forgotten,

of course,

just quite an old fashioned word for saying the thing that we didn't take exactly.

So I think it's important that we talked

about this intuitive part of the opportunity cost.

But maybe we should think a bit graphically and also

put some numbers next to just understand a bit.

What is this opportunity cost? How can we measure? It? May be,

yeah, So we're going to look at it in a lot of graphs and there to come in later videos,

but we can start just by putting some numbers behind it.

Um, and this is actually how we start a lot of big, important economic theories.

Um, so let's start in a traditional economics way,

with a little bit of a model and a very simplified example.

Okay, Okay. Simple, but should be familiar. Okay.

Two countries, country a country. Be okay.

Both of these countries can produce two goods.

Coffee and croissants. Could be cars and houses. Let's say gadgets and gizmos.

It's not really that important exactly what the product is.

Um, so both countries are capable of making these things.

And both countries have this sort of pot of resources they

can use to make that we're going to call those inputs.

Okay.

Land, Labour Capital might be familiar with those,

and they can use that input to create either gadgets

or gizmos combination of the two should they choose.

But when they do that,

they have to take into account how many inputs they need

to they need in order to produce each of these items.

Yeah, So when we're thinking about the cost of what to produce it,

we can only use that input in a very fixed way.

You know, if I dedicate a unit of resource to production of one good,

I can't then use that same unit of resource and the other is already being used.

So we have to think very carefully about how that differs.

So let's make that a difference between country A and Country B.

Okay, so they have the same amount of units of input at Baseline that

they've both got 10 units of input.

They both can produce the same type of goods they can both make gadgets.

They can both make gizmos. Yep, But then the production costs for them.

How many inputs they needed

to produce each of them might not be the same across the two countries. Exactly.

So let's say, gadgets in country a only take 20.5 units of input.

That's really abstract way of saying maybe only take somebody half

an hour to make a gadget rather than a full hour.

But for gizmos, they need the whole unit of input.

So maybe 60 minutes of work,

rather than 30 minutes of work it would take to make a gadget in country a.

Okay,

Country B. Let's get a little bit different here.

So it still takes half a unit input to make a gadget,

but it only it takes a whole two units of input to make it gets my

Okay, So this is also what we have in the table. Right?

So we have just like a summary of what we have there.

So we have a country, a country B in the two columns and then the roads.

We have the two items and then the values that

we have in there is how many inputs you need in

each country in order to make each of the tickets in

order to make one unit of each good exactly that.

So there's quite a lot of information we've just discussed,

and the table is a really neat way of summarising that

Okay, okay.

But we can then also use that information once it's nicely summarised like

that to have a very clear discussion about what we mean by opportunity,

cost

and how that opportunity costs might differ between countries.

So if I'm thinking OK, I want to produce a gadget, I'm country.

So what's going to be the opportunity cost of producing a gadget in country? A.

Okay, so you think about it like this.

If you want to produce a gadget in country A, you're going to need 0.5 units of input,

0.5 units of labour.

If you are dedicating that 0.5 units of input to the production of that gadget.

That means you're not going to use it to produce gizmos.

Okay,

so every resource to take away from business

is going to reduce the gizmo production.

Now, we know from the table that country A requires one unit of input to make a gizmo.

So if we're taking half a unit away,

we're not gonna be able to produce that whole unit.

We're going to be able to produce half a gizmo.

So if we look at kind of the relative costs here, the relative yeah,

relative costs will find a way to put it for every 0.5.

What we need to make the gadget. We're going to be affecting the gizmo production.

Okay,

so that's gonna be the 0.5 that's going to be

the opportunity costs exactly to make an extra gadget,

I'm gonna lose half a gizmo.

Okay, Okay.

So to make it very clear that the opportunity cost of

producing that extra gadget moving that resource to producing that gadget,

the cost of that is the reduction in gizmo production.

And that reduction is equal to not 0.5 gizmos. So basically, how many gizmos.

I'm for going.

I have forgotten, in order to be able to, uh, get my gadget exactly that.

so you'll notice here that we're actually

talking about these relative costs in terms of

how much we've forgotten of the other good

part because we're talking about opportunity cost.

But we're also talking about it, not in monetary terms,

because as much as economists might want to talk about money a lot.

But what's really behind all the money and all the

decisions that we're doing is really the real things,

the things that we have to give up, the resources we're having to move around.

And so that's what we're focusing on here.

So you're saying it's quite important relative part of the relative that were

economists talk about relatives all the time, right?

Relative prices, relative costs,

because I want to talk about the cost of doing one thing

versus another so we can also do the other way around.

Right? So he said, the opportunity cost of producing a gadget

in the country

and the unit is going to be gizmos,

but we can also look at the opportunity cost of producing a gizmo in the same country.

And we have to figure out how many gadgets we

have foregone in order to be able to produce that.

Exactly.

So the opportunity cost of producing a gizmo in country A is going to be to gadgets.

Because I could have used that one unit of input that

I'm using to produce the gizmo to produce two gadgets.

Well, each gadget, it costs me 0.5 units. Exactly that.

And then we can repeat that process for country. Be right. If we want to,

um, produce an extra gadget in country B, then we're gonna lose 0.25 gizmos

and the opportunity cost of producing a gizmo and

country B is going to be four gadgets.

Those four half units of labour.

I need to transfer to gizmos to get the two units of labour I need to make it gives me.

Okay.

Okay,

so that all sounds a bit silly because we've been

talking about gadgets and gizmos for a few minutes now,

and that's not mostly what we think of economies is doing.

Um,

but what we can see is the idea of opportunity cost

and then what you can do with this at a later

stage is use it to really look at international trade and

the reasons behind why countries might do what they do.

David Ricardo actually was one of the first

economists to really think about it like this.

He wasn't talking about gadgets and gizmos.

He was talking about very real trade between Portugal and

the UK and it was between cloth and wine.

And economists still study those kinds of problems today,

and lots of those theories still have a

lot of importance in international trade theory today.

But the important crunchy thing behind the theory,

which you might do when you look at international trade

it's called comparative advantage is this idea of opportunity,

cost and the idea that it's not just how much

do I need to produce something in a country?

But when I move the resources to producing in that country,

I must be taking them away from somewhere else.

And so opportunity Cost is really the driving force behind a lot of those theories,

so we're going to learn more about opportunity costs in the next video and

we're going to use a really important model to help us look at it

so we don't always have to look at the numbers and think about what

would be going on on the whole economy through the production possibility curve.