Production Possibilities and Opportunity Cost
Production Possibility Frontier (PPF): The boundary between those combination
of goods and services that can be produced and those that cannot
o Shows scarcity, as points outside the frontier cannot be produced
o Model Economy: A model that shows the PPF of two goods (changing
variables’ values) while keeping everything else remaining the same.
o Production Efficiency: Is achieved when goods and services are
produced at the lowest possible cost
This occurs on any points on the PPF
Production is inefficient inside the PPF, because resources are unused (idle but could be working) or
misallocated (assigned to tasks for which they are not the best), or both.
Production is impossible outside the PPF
o Trade-Off: Choices along the PPF involves trade-off (variable x (B) and variable y (G) for each other )
Due to limits in labour, land, capital, and entrepreneurship, we must choose which to create more of
Opportunity Cost (OC): Highest-valued alternative forgone due to an action
o Since there are only two goods (B and G) on the PPF, (and due to our lack of technology and resources) some
quantity of one good must be forgone to create more of the other product.
o Decrease in the production of one good divided by increase in the production of another
o OC of producing an additional (B) is equal to the inverse of OC of producing an additional (G)
o OC of (B) increases as the quantity of (B) produced increases. This is because resources are not equally
productive in all activities. Some employees may be better in creating (G) than (B)
Using Resources Efficiently
Allocative Efficiency: Point on the PPF in which goods and services are produced at
the lowest possible cost and in the quantities that provide the greatest possible benefit
o Reached when reached when marginal cost equals marginal benefit
o The greater the quantity of (B) produced, the smaller the MB from (B) and the
less people will give up (G) to get an additional (B). But the greater the
quantity of (B) produced, the greater is the MC of (B) and the more (G) we
must give up to get an additional (B).
o Marginal Cost (MC): OC of producing one more unit of the good
Since OC increases as production of the good increases, marginal cost changes values constantly.
o Preferences: People’s likes and dislikes, and the intensity of these feelings
o Marginal Benefit (MB): The benefit received from consuming one more unit of a good or service
Measured by the most that people are willing to pay for additional unit of a good or service
MB Curve: A curve that shows the relationship between the MB and quantity consumed of it
Unrelated to the PPF, and cannot be derived from it Principle of Decreasing Marginal Benefit: General principle that the more we have of any good or
service, the smaller is its marginal benefit and the less we are willing to pay for an additional unit
As we consume more of a good or service, the more we tire of it and would prefer to switch
Economic Growth: Expansion of production possibilities
o Increases our standard of living, but does not overcome scarcity nor avoid opportunity cost
o To make our economy grow, there is a trade-off – the greater the growth, the greater the opportunity cost
The amount by which our production possibility expands depends on the resources devoted to
technical changes and capital accumulations.