All decisions about spending scarce resources - such as time or money - are economic choices. Each option comes at the cost of missing out on the alternatives;
- if I buy a coffee every day, I can’t afford as many weekend trips.
- Going out with friends tonight means being less prepared for the test tomorrow morning.
- Making a down payment on a home will cause me to miss out on gains from investing that money in the stock market
The opportunity cost of an option is the most valuable alternative.
Opportunity cost between two options is calculated by dividing the value of the opportunities.
For example, if a farmer can produce 100kg of potatoes or 80kg of carrots, the opportunity cost of producing carrots is
(80kg carrots)/(100kg potatoes). Producing .8kg of carrots carries an opportunity cost of 1kg of potatoes.
A producer that can produce more of a good or service than their competitors has an absolute advantage.
When one producer has a lower opportunity cost to produce a good than their competitors, they have a comparative advantage.
When a producer focuses production on a good or service where they have a comparative advantage, the producer increases their specialization.