Problem:

Suppose that Russ has budgeted $20 a month to buy candy bars, music downloads, or some combination of both. If Russ spends all his budget on candy bars he can obtain 40 bars a month; if he buys only downloads, he can buy 20 a month.

1. What is the price of a candy bar?
2. What is the price of a music download?
3. What is the opportunity cost of a music download?
4. What is the opportunity cost of a candy bar?
5. Would the opportunity cost of each good change if Russ decided to increase his monthly budget to $30 for the two items?

Answer:

1. The price of a candy bar is 50 cents. This is found by dividing the $20 budget by the 40 bars he can obtain per month. $.50 = $20/40.
2. The price of a music download is $1. This is found by dividing the $20 budget by the 20 downloads he can obtain per month. $1 = $20/20.
3. The opportunity cost of 1 music download is the number of candy bars given up to get it. That number is 2. The purchase of 1 more music download at $1 per download requires the sacrifice of 2 candy bars at 50 cents each. The cost can be found as the price of a download divided by the price of a candy bar: 2 = $1/$.50.
4. The opportunity cost of 1 more candy bar is ½ (= .5) music downloads. .5 = $.50/$1.
5. No, the opportunity cost would not change because the prices of the two goods would not have changed. The higher budget simply allows Russ to buy more candy bars or music downloads than before. The opportunity cost of music downloads remains 2 candy bars; the opportunity cost of candy bars remains ½ (= .5) music downloads.

Problem:

Suppose that a nation's production possibilities can be represented by the table below:

1. What is the maximum amount of food this economy can produce? How much clothing can it produce at this point?
2. If the economy is producing at alternative C, what is the cost of one more unit of food?
3. If the economy is producing at alternative C, what is the cost of one more unit of clothing?
4. Is this economy subject to the law of increasing opportunity costs? How can you tell?
5. Suppose the economy is currently producing 4 units of food and 16 units of clothing. Is this economy producing efficiently?

Answer:

1. The greatest amount of food is 16 units, achieved by producing at alternative E. At this point, all resources are devoted to food production and none to clothing production. Clothing production is zero.
2. At C, 8 units of food and 14 units of clothing are being produced. By moving to alternative D, 4 additional units of food are produced at the cost of 6 units of clothing. Each of the next 4 units of food costs 6/4 = 1.5 units of clothing.
3. Moving from alternative C to alternative B, the economy gains 4 units of clothing at a cost of 4 units of food. The opportunity cost of the next 1 unit of clothing is then 4/4 = 1 unit of food.
4. Yes—Starting at alternative A, each successive increase in food production requires a larger and larger reduction in clothing. Specifically, the opportunity costs of each successive four units of food are 2 (=20–18), 4 (=18–14), 6 (=14–8), and 8 (=8–0) units of clothing.
5. No—By producing efficiently, the table suggests that the economy can produce 4 units of clothing and 18 units of food (alternative B). This is 2 more clothing than is currently being produced, suggesting the economy is inefficient.