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Opportunity cost is the cost of alternative that has to be forgone so that one can pursue a given action or produce another product. It can also be defined as the difference amid a chosen option and the next available option. It is useful in choosing the type of product to be produced. The two live together and hence have the same resources and opportunities of producing potatoes or chickens depending on the one's choice.
If any linear combination of chickens and potatoes that lies between those extreme points can be produced if he apportions some resources to each, then the following table can be formed. A straight line is formed.
In order to get the best alternative for each individual, opportunity cost for each has to be calculated. Opportunity cost is calculated by dividing the lost option by the gained. Opportunity cost of product on the y-axis is obtained by getting reciprocal of the gradient of the line or can be obtained by diving change in horizontal by change in vertical. The opportunity cost of product on the x-axis is obtained by getting the gradient of the line (this is since the line has constant gradient).
Michele
| Potatoes | 200 | 150 | 100 | 0 |
| Chickens | 0 | 12.5 | 25 | 50 |
Potatoes are on the y-axis and so the opportunity cost will be the reciprocal of the gradient and that is -0.25. The Michelle's opportunity cost of producing potatoes is -0.25.
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Michelle's opportunity cost of producing chickens
Michelle's opportunity cost of producing chickens is obtained by dividing the change in lost (potatoes) by change in gained (Chickens). Change is Potatoes is 200 and change in Chickens is -50 and so the gradient is -4. The opportunity cost of producing chickens over potatoes is -4.
James' opportunity cost of producing potatoes
| Potatoes | 80 | 60 | 40 | 0 |
| Chickens | 0 | 10 | 20 | 40 |
Absolute and comparative advantage and the activities
Michelle has an advantage in potatoes and James in Chickens and so it can be concluded that Michelle has comparative in producing potatoes and James in rearing Chicken. This is because, though the two had the same resources, Michelle produced more potatoes than the number of reared chicken. On the other hand, though James did not rear many chicken as compared to Michele but they were of better fraction in comparison to the produced potatoes when compared to Michelle's.
Suppose the two specialize in an area of their choices, (Michelle in Potatoes and James in Chicken), and then trading of 2.5 pounds of potatoes for 1 chicken, Michelle would be better off than James who will be running at loss. Michelle would produce more potatoes and sell at higher prices but James would rear few chickens but their selling prices are also low. The rating favors potatoes production and this is an advantage to potatoes producer (Michelle).