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View this website for an example of opportunity cost—paying someone else to wait in line for you.
A fundamental principle of economics is that every choice has an opportunity cost. If you sleep through your economics class (not recommended, by the way), the opportunity cost is the learning you miss from not attending class. If you spend your income on video games, you cannot spend it on movies. If you choose to marry one person, you give up the opportunity to marry anyone else. In short, opportunity cost is all around us and part of human existence.
The following Work It Out feature shows a step-by-step analysis of a budget constraint calculation. Read through it to understand another important concept—slope—that is further explained in the appendix The Use of Mathematics in Principles of Economics .
Budget constraints are easy to understand if you apply a little math. The appendix The Use of Mathematics in Principles of Economics explains all the math you are likely to need in this book. So if math is not your strength, you might want to take a look at the appendix.
Step 1: The equation for any budget constraint is:
where P and Q are the price and quantity of items purchased and Budget is the amount of income one has to spend.
Step 2. Apply the budget constraint equation to the scenario. In Alphonso’s case, this works out to be:
Step 3. Using a little algebra, we can turn this into the familiar equation of a line:
For Alphonso, this is:
Step 4. Simplify the equation. Begin by multiplying both sides of the equation by 2:
Step 5. Subtract four burgers from both sides to yield the answer:
Step 6. Notice that this equation fits the budget constraint in [link] . The vertical intercept is 20 and the slope is –4, just as the equation says. If you plug five burgers into the equation, you get zero bus tickets. If you plug other numbers of bus tickets into the equation, you get the results shown in [link] , which are the points on Alphonso’s budget constraint.
| Point | Quantity of Burgers (at $2) | Quantity of Bus Tickets (at 50 cents) |
|---|---|---|
| A | 5 | 0 |
| B | 4 | 4 |
| C | 3 | 8 |
| D | 2 | 12 |
| E | 1 | 16 |
| F | 0 | 20 |
Step 7. Notice that the slope of a budget constraint always shows the opportunity cost of the good which is on the horizontal axis. For Alphonso, the slope is –4, indicating that for every burger he buys, Alphonso must give up four bus tickets.
There are two important observations here. First, the algebraic sign of the slope is negative, which means that the only way to get more of one good is to give up some of the other. Second, the slope is defined as the price of burgers (whatever is on the horizontal axis in the graph) divided by the price of bus tickets (whatever is on the vertical axis), in this case $2/$0.50 = 4. So if you want to determine the opportunity cost quickly, just divide the two prices.
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