Chapter-1, Opportuniy Cost and Economy

Lecture 2
Opportunity Cost
The opportunity cost of an action is the highest-valued alternative forgone. The PPF makes this
idea precise and enables us to calculate opportunity cost. Along the PPF, there are only two
goods, so there is only one alternative forgone: some quantity of the other good. Given our
current resources and technology, we can produce more pizzas only if we produce less cola. The
opportunity cost of producing an additional pizza is the cola we must forgo. Similarly, the
opportunity cost of producing an additional can of cola is the quantity of pizza we must forgo. In
Fig. 2.1, if we move from point C to point D, we get 1 million more pizzas but 3 million fewer
cans of cola. The additional 1 million pizzas cost 3 million cans of cola. One pizza costs 3 cans
of cola. We can also work out the opportunity cost of moving in the opposite direction. In Fig.
2.1, if we move from point D to point C, the quantity of cola produced increases by 3 million
cans and the quantity of pizzas produced decreases by 1 million. So if we choose point C over
point D, the additional 3 million cans of cola cost 1 million pizzas. One can of cola costs 1/3 of a
pizza.
Increasing Opportunity Cost

The opportunity cost of a pizza increases as the quantity of pizzas produced increases. The
outward-bowed shape of the PPF reflects increasing opportunity cost. When we produce a large
quantity of cola and a small quantity of pizza— between points A and B in Fig. 2.1—the frontier
has a gentle slope. An increase in the quantity of pizzas costs a small decrease in the quantity of
cola—the opportunity cost of a pizza is a small quantity of cola. When we produce a large
quantity of pizzas and a small quantity of cola—between points E and F in Fig. 2.1—the frontier
is steep. A given increase in the quantity of pizzas costs a large decrease in the quantity of cola,
so the opportunity cost of a pizza is a large quantity of cola. The PPF is bowed outward because
resources are not all equally productive in all activities. People with many years of experience
working for PepsiCo are good at producing cola but not very good at making pizzas. So if we
move some of these people from PepsiCo to Domino’s, we get a small increase in the quantity of
pizzas but a large decrease in the quantity of cola. Similarly, people who have spent years
working at Domino’s are good at producing pizzas, but they have no idea how to produce cola.
So if we move some of these people from Domino’s to PepsiCo, we get a small increase in the
quantity of cola but a large decrease in the quantity of pizzas. The more of either good we try to
produce, the less productive are the additional resources we use to produce that good and the
larger is the opportunity cost of a unit of that good
Economy:
An economy is an area of the production, distribution and trade, as well
as consumption of goods and services by different agents. A given economy is the result of a set
of processes that involves its culture, values, education, technological evolution, history, social
organization, political structure and legal systems, as well as its geography,
Four types of economy:
THE TRADITIONAL ECONOMY:

Culture defines the traditional economic system. It is built around the ways of society: that is, the
livelihood of the people determines the products and services.The customs and beliefs of a
community are considered in developing goods and services in the area.The people in this
economic system believe what was practiced by their ancestors is right and should not be
questioned.Therefore, they continue the habits from the past in their present days.The roles of the
individuals are defined by the customs of their elders and ancestors.
For instance, in some African countries, you will find the concept of the ruling tribes and
monarchies.
THE FREE MARKET ECONOMY:

It is a capitalist economic system where production of goods and services is driven by the
consumer practices. The demand pushes supply.It also makes good use of the Laissez-faire belief
that a market will work best under no government interruptions.Therefore, in a free market
economy, there is no government interference.
THE COMMAND ECONOMY
In this economy, the government owns and runs all central resources.Among other unique
features is that the government makes all decisions regarding what to and how is being
manufacturedIn this case, the government is not only involved in making all decisions but it is
also included in the price formulation and control. In this system, people work for public goods.
The interests and profits are shared amongst the citizens.
THE MIXED ECONOMY:
The mixed economic system combines the command economy and free market economy, so it
has the features of both of these two economies. The mixed economic system is characterized by
government interference but not to the extreme. Freedom to choose and opportunities to innovate
are offered.
Types of Economic Systems
There are many types of economies around the world. Each has its own
distinguishing characteristics, although they all share some basic features.
Each economy functions based on a unique set of conditions and
assumptions. Economic systems can be categorized into four main types:
traditional economies, command economies, mixed economies, and market
economies.
1. Traditional economic system
The traditional economic system is based on goods, services, and work, all of
which follow certain established trends. It relies a lot on people, and there is
very little division of labor or specialization. In essence, the traditional
economy is very basic and the most ancient of the four types.
Some parts of the world still function with a traditional economic system. It is
commonly found in rural settings in second and third world nations, where
economic activities are predominantly farming or other traditional income-
generating activities.
There are usually very few resources to share in communities with traditional
economic systems. Either few resources occur naturally in the region or access
to them is restricted in some way. Thus, the traditional system, unlike the other
three, lacks the potential to generate a surplus. Nevertheless, precisely
because of its primitive nature, the traditional economic system is highly
sustainable. In addition, due to its small output, there is very little wastage
compared to the other three systems.
2. Command economic system
In a command system, there is a dominant centralized authority – usually the

government – that controls a significant portion of the economic structure.
Also known as a planned system, the command economic system is common
in communist societies since production decisions are the preserve of the
government.
If an economy enjoys access to many resources, chances are that it may lean
towards a command economic structure. In such a case, the government
comes in and exercises control over the resources. Ideally, centralized control
covers valuable resources such as gold or oil. The people regulate other less
important sectors of the economy, such as agriculture.
In theory, the command system works very well as long as the central
authority exercises control with the general population’s best interests in
mind. However, that rarely seems to be the case. Command economies are
rigid compared to other systems. They react slowly to change because power
is centralized. That makes them vulnerable to economic crises or emergencies,
as they cannot quickly adjust to changing conditions.
3. Market economic system
Market economic systems are based on the concept of free markets. In other
words, there is very little government interference. The government exercises
little control over resources, and it does not interfere with important segments
of the economy. Instead, regulation comes from the people and the
relationship between supply and demand.
The market economic system is mostly theoretical. That is to say, a pure

market system doesn’t really exist. Why? Well, all economic systems are
subject to some kind of interference from a central authority. For instance,
most governments enact laws that regulate fair trade and monopolies.
From a theoretical point of view, a market economy facilitates substantial

growth. Arguably, growth is highest under a market economic system.
A market economy’s greatest downside is that it allows private entities to

amass a lot of economic power, particularly those who own resources of great
value. The distribution of resources is not equitable because those who
succeed economically control most of them.
4. Mixed system
Mixed systems combine the characteristics of the market and command

economic systems. For this reason, mixed systems are also known as dual
systems. Sometimes the term is used to describe a market system under strict
regulatory control.
Many countries in the developed western hemisphere follow a mixed system.

Most industries are private, while the rest, composed primarily of public
services, are under the control of the government.
Mixed systems are the norm globally. Supposedly, a mixed system combines
the best features of market and command systems. However, practically
speaking, mixed economies face the challenge of finding the right balance
between free markets and government control. Governments tend to exert
much more control than is necessary.
Final Word
Economic systems are grouped into traditional, command, market, and mixed
systems. Traditional systems focus on the basics of goods, services, and work,
and they are influenced by traditions and beliefs. A centralized authority
influences command systems, while a market system is under the control of
forces of demand and supply. Lastly, mixed economies are a combination of
command and market systems

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Lecture 2

Increasing Opportunity Cost

Four types of economy:

THE TRADITIONAL ECONOMY:

THE FREE MARKET ECONOMY:

THE COMMAND ECONOMY

THE MIXED ECONOMY:

Types of Economic Systems

1. Traditional economic system

2. Command economic system

In a command system, there is a dominant centralized authority – usually the

The market economic system is mostly theoretical. That is to say, a pure

From a theoretical point of view, a market economy facilitates substantial

A market economy’s greatest downside is that it allows private entities to

Mixed systems combine the characteristics of the market and command

Many countries in the developed western hemisphere follow a mixed system.

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