PPF & Opportunity Cost

A-level Economics

What is the PPF? What is opportunity cost and how do they relate?

This is a need to know topic for your exam.  It’s easy to get carried away with this one but there are few key things you HAVE to remember and make links with. I will highlight these as we go along.

What is the PPF?

First of all, the PPF shows all possible output combinations between two goods in an economy.  Let’s say for example we have two goods: guns and missiles (lovely example, I know).  I will show this below on the PPF curve.

When producing on the PPF curve, (so point A, B, C and D) the firm is productively efficient.  This is because all resources are being utilised and no more can be made.  It is impossible to produce beyond the PPF, because this is your maximum capacity.  However, you can produce inside the PPF, which would make the firm productively inefficient.

If the firm wanted to it could also produce at point C or D.  This would mean having to give up all of the other good.  At point C, the firm has to give up all of its missiles and at point D, the firm has to give up all of its guns.  However, the firm is still productively efficient because they are using all of the factor inputs as much as they can.
 

Understanding how PPF and Opportunity Cost are related

When producing on the curve, the firm is faced with a choice.  It can produce at point A, B, C and D. This choice presents a problem for the firm, because it has to start giving up one good so it can make more of another.  This is called the opportunity cost.  If the firm no longer wants to produce at point A and wants to produce at point B, it will have to give up 5 missiles in order to produce 500 more guns.  The opportunity cost of producing at point B in terms of missiles is equal to 5 missiles (because that is what you had to give up).

Another thing to mention is that the shape of the PPF makes a difference to the opportunity cost.  If you see a straight PPF, it means that there is a constant opportunity cost.  So producing 5 more missiles will mean giving up 500 guns.

However, there is a different style of PPF curve (for a start, it actually looks curvy). if the PPF is curved, the opportunity cost is changing.  It is not the same opportunity cost at all points. See the diagram below.

Find out what shift the PPF Curve. Watch the video below!

So, what I want you to remember is this:

1. PPF curve shape affects whether or not the opportunity cost is constant

2. If you produce on the curve, you are productively efficient. On the curve, you also face an opportunity cost.

3. If you produce inside the curve, you are productively inefficient. Inside the curve, you do not face an opportunity cost because you can produce more of both until you reach max capacity.

4. Definition of PPF curve: “diagram that shows all possible output combinations between two goods, in a given moment in time.”

5. Definition of opportunity cost: “the cost of the next best alternative foregone.”

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