2-858-07 Economic Problems and Policy Analysis
Appendix to Chapter 4
Review material on the opportunity cost and
the marginal rate of substitution (MRS)
Useful for class assignment # 1
2-858-07 Economic Problems and Policy Analysis
Constant opportunity cost
The opportunity cost of one
coconut is measured by the
number of sacrificed fish all
while remaining on the same
Production Possibilities Frontier
(PPF).
2-858-07 Economic Problems and Policy Analysis
Constant opportunity cost
Fish
y
 2
x
We need to give up the
production of 40 fishes to
produce the first 20
coconuts. The opportunity
cost = - 40y/20x= -2y/x =
slope of the PPF. Therefore,
the physical cost of one extra
coconut is 2 fishes.
Coconuts
2-858-07 Economic Problems and Policy Analysis
Constant opportunity cost
Fish
y
 2
x
The
opportunity
cost is
constant.
40 fishes must be sacrificed
to produce the next 20
coconuts. The opportunity
cost = - 40y/20x= -2y/x
=slope of the PPF. Notice,
the opportunity cost of one
unit of coconut is also 2
fishes.
Coconuts
2-858-07 Economic Problems and Policy Analysis
Increasing opportunity cost
Fish
y
 0.2
x
We need to give up the
production of 4 fishes to
produce the first 20
coconuts. The opportunity
cost = - 4y/20x= -0.2y/x =
slope of the line connecting
E1 to E2.
Coconuts
2-858-07 Economic Problems and Policy Analysis
Increasing opportunity cost
Fish
y
 0.6
x
To produce the next 20
coconuts, the production of
12 fishes must be forgone.
The opportunity cost = 12y/20x= -0.6y/x = slope of
the line connecting E2 to E3.
Coconuts
2-858-07 Economic Problems and Policy Analysis
Increasing opportunity cost
Fish
40
y
 1.6
x
We need to give up the
production of 20 fishes to
produce 12 additional
coconuts. The opportunity
cost = - 20y/12x= -1.6y/x =
slope of the line connecting
E7 to E8.
The opportunity
cost is increasing.
The more units of
x are produced,
Coconuts
the higher the
opportunity cost
of each extra unit.
2-858-07 Economic Problems and Policy Analysis
The opportunity cost of small increments
of x (coconuts)
Fish
When the variations in x
become smaller (tend to
zero), the opportunity
cost is equal to the slope
of the tangent at the point
of variation.
Coconuts
2-858-07 Economic Problems and Policy Analysis
Decreasing marginal evaluation (MRS)
Fish
From the point of view of the consumer,
the value of one coconut is measured
by the number of fish that she is ready
to sacrifice all while maintaining the
same level of satisfaction, i.e. remaining
on the same indifference curve.
Coconuts
2-858-07 Economic Problems and Policy Analysis
Decreasing marginal evaluation
Fish
y
 1.57
x
The consumer is ready to sacrifice 22
fishes in exchange for 14 additional
coconuts. The marginal evaluation =
Marginal Rate of Substitution (MRS)= 22y/14x = -1.57y/x = slope of the line
linking E1 to E2.
Coconuts
2-858-07 Economic Problems and Policy Analysis
Decreasing value
Fish
The consumer is ready to sacrifice 8
fishes in exchange for 8 extra coconuts.
The marginal evaluation= MRS= -8y/8x
= -1y/x = slope of the line linking E2 to
E3.
y
 1
x
The value given by
the consumer to a
good is
decreasing. The
more x is
consumed, the
less its value in
terms of y.
Coconuts
2-858-07 Economic Problems and Policy Analysis
Marginal evaluation for small increments
of x (coconuts)
Fish
When the variations in x
become smaller (tend to
zero), the marginal
evaluation or MRS
corresponds to the slope
of the tangent at the
point of variation.
Coconuts