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Context : simply having a look at a basic book on economics ( with no previous background) in order to grasp basic phenomena regarding labour market.

The above statement comes from Microeconomics Demystified ( McG.H. Editor):

I Think I roughly understand the definitions.

Opportunity cost of producing a good A ( horizontal axis) rather than good B : the slope of the Production Frontier , i.e. $\frac {\Delta B}{\Delta A}$

Relative price : ratio of the price of one good over one unit of the other good .

I think I suffer from a lack of economic intuition, since I'm not enlightened at all by the example given in the text.

Could you please provide me with a simple model that could help me visualize what is happening?

Also, ( correct me if I am wrong) it seems to me that an opportunity cost is by definition a negative number. In that case, how can a price be less than an opportunity cost?

Final question : does " an opportunity cost of wheat equal to 4 barrels" mean that the slope of the PPF ( with wheat on the X axis, and oil on the Y axis) is equal to $- 1/4$ ?

ORIGINAL TEXT:

"If the relative price is less than the opportunity cost, then the individual is better-off not producing the product because doing so will incur a loss or a negative profit.

This can be extended from trade between individuals to trade between countries. If the relative price of wheat to oil is, say, four barrels of oil per bushel of wheat, then the countries that have an opportunity cost of wheat less than four barrels of oil are better off producing wheat and selling it to the oil producing countries for a profi t. Likewise, those countries with an opportunity cost of a barrel of oil less than onefourth of a bushel of wheat are better off producing oil and trading with wheat producing countries. In this case, both the wheat producing country and the oil producing country are able to profi t when they exploit their comparative advantage."

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Could you please provide me with a simple model that could help me visualize what is happening?

A example is as follows suppose that the relative price of cloth is 4 units of wine. Hence by selling one cloth you can get 4 units of wine $\left(\frac{p_c}{p_w}=4\right)$. Next suppose that opportunity cost of producing cloth is that you have to give up 5 units of wine that you could produce if you would produce wine rather than cloth.

Here the price you charge for cloth is 4 wine, your opportunity cost of producing that 1 unit of cloth is to give up 5 units of wine (i.e. your opportunity cost $c_o=5w$). If you get 4 units of wine for cloth but you loose 5 units of wine in producing it, it is irrational to produce the cloth (since your profit will be negative).

Also, ( correct me if I am wrong) it seems to me that an opportunity cost is by definition a negative number. In that case, how can a price be less than an opportunity cost?

You are wrong here. Opportunity cost or any cost for that matter is not by definition negative. Costs themselves are positive numbers. A negative cost would mean you are actually getting something.

I think you might get confused because when you do your personal finance to see how much you earn you will probably take your income and subtract the costs for housing etc. But that does not mean the costs themselves are negative. You are just finding the difference between costs and income. For example, I am 189cm tall my brother is 184cm tall, if I want to calculate difference in our heights I would subtract his height from mine, but despite that I am subtracting to find the difference it does not mean my brother's height is negative. Costs themselves are positive numbers. If you are asked to report costs you wouldn't state costs were -\$4000, the correct way would be to say cost were \$4000.

Final question : does " an opportunity cost of wheat equal to 4 barrels" mean that the slope of the PPF ( with wheat on the X axis, and oil on the Y axis) is equal to −1/4 ?

Yes, the slope of PPF is -1/4 in that case.

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  • $\begingroup$ Clear and precise answer. Thanks! $\endgroup$ Apr 15, 2022 at 9:28

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