The Economic Problem
Production Possibilities and Opportunity Cost
• The production possibilities frontier (PPF) is the boundary between those combinations of
goods and services that can be produced and those that cannot.
• The figure below shows the production possibilities frontier for cola and pizza.
• The table lists some combinations of the quantities of cola and pizza that can be produced given
the resources available.
• The dots marked A, B, C, D, E, and F on the PPF correspond to the six combinations in the table.
• If we stop producing pizza and move all the people who produce pizza into producing cola, we
produce at point A.
• If we stop producing cola and move all the people who produce cola into producing pizza, we
produce at point F.
• We can produce at any point on the PPF—on the blue line—or inside the PPF—in the orange
• We cannot produce at any point outside the PPF.
• We achieve production efficiency if we produce goods and services at the lowest possible cost.
• Production efficiency occurs at all points on the PPF.
• Possible production points inside the PPF such as point Z are inefficient.
• The opportunity cost of an action is the highest-valued alternative forgone.
• If we move from point C to point D, we must give up 3 million cans of cola to produce 1 million
more pizzas. The additional million pizzas cost 3 million cans of cola.
• Opportunity cost is a ratio.
• It is the decrease in the quantity produced of one good divided by the increase in the quantity
produced of the other good as we move along the production possibilities frontier. • The PPF reflects increasing opportunity cost.
• The PPF is bowed outward because resources are not all equally productive in all activities.
Using Resources Efficiently
• Marginal cost is the opportunity cost of producing one more unit.
• Let’s find the marginal cost of pizza.
• In figure part (a) above if pizza production increases from zero to 1 million, the quantity of cola
decreases from 15 million cans to 14 million cans.
• So the opportunity cost of the first million pizzas is 1 million cans of cola.
• If pizza production increases from 1 million to 2 million, the quantity of cola decreases from 14
million cans to 12 million cans.
• So the opportunity cost of the second million pizzas is 2 million cans of cola.
• If pizza production increases from 2 million to 3 million, the quantity of cola decreases from 12
million cans to 9 million cans.
• So the opportunity cost of the third million pizzas is 3 million cans of cola.
• The opportunity cost of a million pizzas is also the marginal cost of producing a million pizzas.
• Figure part (b) graphs this marginal cost. • Preferences are a description of a person’s likes and dislikes.
• To describe preferences, economists use marginal benefit.
• Marginal benefit of a good or service is the benefit received from consuming one more unit of
• The marginal benefit curve shows the relationship between marginal benefit of a good and the
quantity of that good consumed.
• The more we have of any good or service, the smaller its marginal benefit and the less we are
willing to pay for an additional unit of it.
• We call this tendency the principle of decreasing marginal benefit.
• The figure below shows the marginal benefit curve.
• The points