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The law of increasing opportunity cost is a concept that is often employed in business and economic circles. Essentially, this law states that, as additional units of a good are manufactured, the opportunity cost associated with that production will also increase. Understanding this phenomenon can help businesses determine if choosing to increase production is worth the effort, or if the increasing opportunity costs mean that the benefits of doing so are reduced sufficiently to merit maintaining production at a lower level.
To understand this law, it is important to first define what is mean by opportunity cost itself. This is sometimes referred to as foregone production, meaning that, in order to choose one strategy or method of producing a good, resources must be diverted from producing other goods. The opportunity cost is representative of what could be gained by using those resources in a different way and how that use compares to the benefits ultimately generated by the option that was selected.
One way to understand how the law of increasing opportunity cost functions is to consider a farmer who is deciding how to allocate plats of farmland to the growth of two crops. Rather than allocating the available land equally between the two, the farmer chooses to plant 70% of the land in corn, and reserve the rest for soybeans. Even though the production of corn is increased thanks to the allocation of additional resources to that effort, this may cause the cost of producing soybeans on the reduced amount of land to go up, owing to the reduced return on a venture that includes a number of fixed expenses. At this juncture, the farmer will need to determine if the benefits of raising more corn offsets the increased costs of raising fewer soybeans, then adjust the allocation of resources as necessary to generate the most desirable end.
The general concept can be used in a number of ways. Businesses can make use of it when planning production quotas of different products. Departments can use the idea when allocating resources to different projects. Even small businesses can take the law of increasing opportunity costs into consideration when designing the displays and layout of a store’s shopping area, or allocating time to certain types of back office functions. By keeping this concept in mind, it is often much easier to arrive at a plan of action that provides for achieving the greatest benefit while keeping losses in check.
@ParallelLine: I think you're thinking about increasing costs as they relate to the long run average cost (LRAC)curve. If that's the case, you're correct. On fact, it's called diseconomies of scale, defined as the portion of the LRAC where as production increases by an additional unit, average costs increase.
But we generally assume that an infinite number of plant sizes are available so it's not actually a step function.
In general, increasing opportunity costs refer to the production possibility frontier model and reflect the fact that inputs are not perfect substitutes for one another. Because of this, more and more of one input has to be given up as more of one good is produced.
Think of a (very) small
economy in which only two goods are produced, say, guns and butter. As more and more guns are produced, inputs are shifting out of butter production to gun production. Think about just the labor. People who have always made butter are not going to be very good at making guns, right? When you start increasing the number of guns made you're going to move the people who are better at gun production over because they make guns more efficiently. But eventually, you're going to move the lo-tech workers who have only ever worked in the dairy over, and they're just not going to be as efficient as the first ones. Therefore, your opportunity costs will increase.
By the way, the definition of opportunity cost is whatever must be given up in order to get something else. Example: you just spent (wasted??) 5 minutes reading this response which is time that you could have spent doing something else. So the opportunity cost of reading this is the time you lost not doing the other activity.
If you feel the urge to torture yourself some more, let me know if you have any questions.
I think another example of this is having to build a brand new plant for the production of the marginal good when the existing plant is at capacity. This means that there is a step function when considering the marginal cost of production.
Also, I guess that the law of increasing opportunity cost is the opposite of economies of scale.
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