Opportunity Sets emerge directly as a result of one of the Economics Five Core Ideas, the idea of Trade-Offs and scarcity. Because all resources are scarce, including time, people must make choices on daily basis and must give up something in order to get something else. Opportunity sets depict all the choices available to individuals, as defined by budget and time constraints.
Opportunity sets are so simple that they may seem almost innate to us. Since most of us don’t take morning dips in money, most of us have probably faced a dilemma of choosing which item to buy. Examples below depict such situations in order to explain what opportunity sets are.
Suppose that Mike is attending 10th grade in Texas High. Over the summer, Mike worked at his local Mickey Dees and now has $100 in cash that he desperately wants to spend. He has two products that he can purchase: Books and Computer Games. He goes to his local Books & Games store and sees that each book costs $5 and each computer game costs $25. With the $100 that he has in his pocket, he is able to buy 20 books (100/5 = 20), 4 computer games (100/25 = 4), or any combination of the two. In order to make a wise Economic decision, he takes out his handy-dandy notebook and proceeds to graph his opportunity set.
First, he starts off by setting up a basic graph. Quite arbitrarily he selects his x-axis (horizontal line) to represent Computer Games, and his y-axis (vertical line) to represent Books. He numbers his x-axis 1 through 4, and his y-axis 1 through 20. He puts a point at (0,20) coordinate, which means that at that point he is able to buy 20 Books and 0 Computer Games. He then puts another point at the (4,0) coordinate, which means that at that point he is able to buy 4 Computer Games and 0 Books. Then, he carefully draws a line from one point to another. The resulting graph is Mike’s opportunity set for purchasing Books and Computer Games.
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ ___
___//////////////////////////////////////// | |
/ //////////////////////////////////////// \ |___|
| | | |
| | | |
| | |___|
| Mike’s Opportunity Set for | | |
| Books and Computer Games | | N |
| | | O |
| ^ A | | * |
| 20-* | | 2 |
| | o | | |
| | o | | |
| | o E | | |
| 15-+-------o-------* | | |
| | o | | | |
| B | o | | | |
| o | D o | | | |
| o 10-+-------* o | | |
| k | | | o | | |
| s | | | o | | |
| | | | o C | | |
| 5-+-------+-------+-------* | | |
| | | | | o | | |
| | | | | o | | |
| | | | | o B | | |
| -|-------+-------+-------+-------*> | | |
| 0 1 2 3 4 | | |
| Computer Games | | |
| | |^^^|
| | \ /
| | \_/
\___________________________________________/ V
This graph allows Mike to see how he may allocate his resources. To refresh his memory of Economics, he plots several points on his graph and tries to remember exactly what each one means and how each one is unique.
Point A is located at (0,20). To be at this point, Mike would have to spend all of his money on Books and not buy any Computer Games. $100 = 20*$5 + 0*$25
Point B is located at (4,0). To be at this point, Mike would have to spend all of his money on Computer Games and not buy any Books. $100 = 0*$5 + 4*$25
Point C is located at (3,5). To be at this point, Mike would have to buy 3 Computer Games and 5 Books. $100 = 3*$25 + 5*$5
Point D is located at (1,10). To be at this point, Mike would have to buy 1 Computer Game and 10 Books. $100 > 1*$25 + 10*$5. In this case, Mike’s available resources ($100) will exceed the amount he will spend, since $25+$50 is only $75. This means that Mike will not be using his resources efficiently, and $25 will go to waste. This is an example of inefficiency.
Point E is located at (2,15). To be at this point, Mike would have to buy 2 Computer Games and 15 Books. $100 < 2*$25 + 15*$5. In this case, Mike’s available resources ($100) will not be enough to purchase all of those products, and though Mike may want to be at that point, it is unattainable due to scarcity.
Of course, scarcity is not only limited to money. Sometimes time may become a problem, especially once one gets filthy rich, and has to make choices based on time rather than money. Let’s continue with Mike’s story. Let’s suppose that Mike decides that he wants to buy 2 Computer Games and 15 Books, so he decides to go and get a job. On his way home, he realizes that he will have to give up his homework time in order to earn the dough, so he decides to sketch yet another opportunity set. He only has 12 hours available each day, which means that he can either spend 12 hours working, 12 hours doing homework, or any combination of the two.
He decides to use x-axis for Doing Homework and use the y-axis for Work.
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ ___
___//////////////////////////////////////// | |
/ //////////////////////////////////////// \ |___|
| | | |
| | | |
| | |___|
| Mike’s Opportunity Set for | | |
| Working and Doing Homework | | N |
| | | O |
| ^ A | | * |
| 12-* | | 2 |
| | o | | |
| | o | | |
| | o E | | |
| 9-+-------o-------* | | |
| | o | | | |
| | o | | | |
| W | D o | | | |
| o 6-+-------* o | | |
| r | | | o | | |
| k | | | o | | |
| | | | o C | | |
| 3-+-------+-------+-------* | | |
| | | | | o | | |
| | | | | o | | |
| | | | | o B | | |
| -|-------+-------+-------+-------*> | | |
| 0 3 6 9 12 | | |
| Doing Homework | | |
| | |^^^|
| | \ /
| | \_/
\___________________________________________/ V
At point A, Mike would be working all of his time and not doing any of his Homework. Since failing school is not an option for Mike, he cannot use this point.
At point B, Mike would be spending all of his time doing homework and wouldn’t earn any money. Since Mike is a smart guy, he can get away with using less than 12 hours on homework and be able to make money. Therefore, point B is not a very good choice, either.
At point C, Mike would be spending 9 hours on his homework and 3 hours working. Though this may be a bit overboard, it’s a reasonable option, one that would give him a steady income while leaving enough room for those occasional tough projects.
At point D, Mike would be spending 3 hours on his homework and 6 hours working. If Mike chooses this, he will be wasting 3 hours doing nothing every day. Therefore, it isn’t as good of an option as C.
At point E, Mike would be spending 6 hours on his homework and 9 hours working. This is a very good option for Mike, since he’d have plenty of time to do his homework and work overtime on a full-time job! Unfortunately, this option is unattainable since he can only spend 12 hours.
In general, it can be said that anything lying on the graph is possible, anything below the graph is inefficient, and anything above the graph is unattainable due to scarcity.
As you can see, opportunity sets are pretty simple, and many people think they are common sense. When this principle is applied to production choices of governments or firms, instead of choices that individual consumers make, efficiency comes into play. As a result, the Opportunity Set turns into a curve that is commonly referred to as the Production Possibilities Curve. A common example is the “Guns and Butter Trade-Off”, where certain machinery is inefficient in producing Guns, while other machinery is not intended to produce Butter. However, Production Possibilities Curves are a topic beyond the scope of this node.
http://www.investorwords.com/
Stiglitz, Joseph, Carl Walsh. Economics Third Edition. New York: Norton, 2002