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Lesson summary: Opportunity cost and the PPC

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In this lesson summary, review the key concepts, key terms, and key graphs for understanding opportunity cost and the production possibilities curve.
The Production Possibilities Curve (PPC) is a model used to show the tradeoffs associated with allocating resources between the production of two goods. The PPC can be used to illustrate the concepts of scarcity, opportunity cost, efficiency, inefficiency, economic growth, and contractions.
For example, suppose Carmen splits her time as a carpenter between making tables and building bookshelves. The PPC would show the maximum amount of either tables or bookshelves she could build given her current resources. The shape of the PPC would indicate whether she had increasing or constant opportunity costs.

Key terms

production possibilities curve (PPC)(also called a production possibilities frontier) a graphical model that represents all of the different combinations of two goods that can be produced; the PPC captures scarcity of resources and opportunity costs.
opportunity costthe value of the next best alternative to any decision you make; for example, if Abby can spend her time either watching videos or studying, the opportunity cost of an hour watching videos is the hour of studying she gives up to do that.
efficiencythe full employment of resources in production; efficient combinations of output will always be on the PPC.
inefficient use (under-utilization) of resourcesthe underemployment of any of the four economic resources (land, labor, capital, and entrepreneurial ability); inefficient combinations of production are represented using a PPC as points on the interior of the PPC.
growthan increase in an economy's ability to produce goods and services over time; economic growth in the PPC model is illustrated by a shift out of the PPC.
contractiona decrease in output that occurs due to the under-utilization of resources; in a graphical model of the PPC, a contraction is represented by moving to a point that is further away from, and on the interior of, the PPC.
constant opportunity costswhen the opportunity cost of a good remains constant as output of the good increases, which is represented as a PPC curve that is a straight line; for example, if Colin always gives up producing 2 fidget spinners every time he produces a Pokemon card, he has constant opportunity costs.
increasing opportunity costswhen the opportunity cost of a good increases as output of the good increases, which is represented in a graph as a PPC that is bowed out from the origin; for example Julissa gives up 2 fidget spinners when she produces the first Pokemon card, and 4 fidget spinners for the second Pokemon card, so she has increasing opportunity costs.
productivity(also called technology) the ability to combine economic resources; an increase in productivity causes economic growth even if economic resources have not changed, which would be represented by a shift out of the PPC.

Key model

Figure 1: A production possibilities curve that reflects increasing opportunity costs
The Production Possibilities Curve (PPC) is a model that captures scarcity and the opportunity costs of choices when faced with the possibility of producing two goods or services. Points on the interior of the PPC are inefficient, points on the PPC are efficient, and points beyond the PPC are unattainable. The opportunity cost of moving from one efficient combination of production to another efficient combination of production is how much of one good is given up in order to get more of the other good.
The shape of the PPC also gives us information on the production technology (in other words, how the resources are combined to produce these goods). The bowed out shape of the PPC in Figure 1 indicates that there are increasing opportunity costs of production.
We can also use the PPC model to illustrate economic growth, which is represented by a shift of the PPC. Figure 2 illustrates an agent that has experienced economic growth. Combinations that were once impossible, such as 6 iPads and 4 watches, are now on the new PPC, thanks to the increase in resources or technology.
Figure 2: PPC showing economic growth

Key Equations and Calculations: Calculating opportunity costs:

To find the opportunity cost of any good X in terms of the units of Y given up, we use the following formula:
start text, O, p, p, o, r, t, u, n, i, t, y, space, c, o, s, t, space, o, f, space, e, a, c, h, space, u, n, i, t, space, o, f, space, g, o, o, d, space, X, end text, equals, left parenthesis, Y, start subscript, 1, end subscript, minus, Y, start subscript, 2, end subscript, right parenthesis, divided by, left parenthesis, X, start subscript, 1, end subscript, minus, X, start subscript, 2, end subscript, right parenthesis, start text, space, u, n, i, t, s, space, o, f, space, g, o, o, d, space, Y, end text

Common Misperceptions

  • Not all costs are monetary costs. Opportunity costs are expressed in terms of how much of another good, service, or activity must be given up in order to pursue or produce another activity or good. For example, when you head out to see a movie, the cost of that activity is not just the price of a movie ticket, but the value of the next best alternative, such as cleaning your room.
  • Going from an inefficient amount of production to an efficient amount of production is not economic growth. For example, suppose an economy can make two goods: chocolate donuts and cattle prods. But half of their donut machines aren’t being used, so they aren’t fully using all of their resources. Graphically, that would be represented by a combination of goods in the interior of their PPC. If they then put all of those donut machines to work, they aren’t acquiring more resources (which is what we mean by economic growth). Instead, they are just using their resources more efficiently and moving to a new point on the PPC.
  • On the other hand, if this economy is making as many donuts and cattle prods as it can, and it acquires more donut machines, it has experienced economic growth because it now has more resources (in this case, capital) available. This would be represented in a PPC graph as a shift outward of the entire PPC curve.

Discussion Questions

  • How would you show with a PPC that a country has constant opportunity costs of production?
  • Using a correctly labeled PPC model, show an economy that has increasing opportunity costs that can produce cattle prods and chocolate donuts that is underutilizing its labor.

Want to join the conversation?

  • duskpin ultimate style avatar for user Aulia Aliyev
    For discussion question number 1, is it correct if I say: with two product variables in the two axis, it can be shown by a straight line going down from left to right on the graph?
    (20 votes)
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    • starky tree style avatar for user melanie
      Yes, but with a small additional needed element.

      For example, suppose you can produce either 20 paper airplanes in a day or 40 drawings of puppies in a day and you had constant opportunity costs. On one axis you would label "number of paper airplanes" and on the other you would label "number of puppy drawings". Then you would draw a straight, downward sloping line connecting those two axes that connects at 40 on the puppy axis and connects at 20 on the paper airplane axis.
      (19 votes)
  • blobby green style avatar for user bimarshakalikote
    How can scarcity be represented in the graph of PPC?
    (8 votes)
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    • hopper cool style avatar for user Siddhant
      Answer by example - In the example of rabbits and berries, you have to allocate a scarce resource, namely time, in order to acquire other resources. Maybe in that way rabbits and berries are scarce (since you are willing to give up your time in exchange, and you are a rational being).

      Please correct me if I'm wrong.
      (5 votes)
  • blobby green style avatar for user Jonathan Cadoret
    I'm not quite sure that I understand the Opportunity Cost equation. It says X=(Y1-Y2)/(X1-X2) But in the iPhones and Watch example, it seems to use this equation
    X=(Y1-Y2)/(X2-X1). The X1 and X2 variables ares interchanged.
    Is there a reason for this?
    (7 votes)
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    • blobby green style avatar for user SpencerAssiff
      The number itself will be the same in either case. What changes is the sign of the equation (in this case negative). This should make sense because in order for our iPhones production to increase, we need our watch production to decrease. The difference between two x values will be the same, what changes is the direction (or the sign).
      (2 votes)
  • blobby green style avatar for user mcampbell
    how can scarcity can be determined in ppc
    (4 votes)
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  • blobby green style avatar for user Mathew Ajayi
    I just got a question wrong, the answer stating that a bowed curve of PPC meant different resources allocation.
    In no way was it suggested in video or read-through.
    Confused please elaborate.
    (4 votes)
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  • piceratops seedling style avatar for user Rachel Hoiby
    1. The PPC would be a straight line with a constant slope from the X-axis to the Y-axis.
    (3 votes)
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  • blobby green style avatar for user mayamasood9
    is opportunity cost in the PPC being represented by the shape of the curve?
    (2 votes)
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  • male robot hal style avatar for user Vinay Sharma
    Why does it mean when opportunity cost is constant along the ppc?
    I know it’s because of the linear curve, but what is the underlying concept?
    (2 votes)
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    • hopper cool style avatar for user Seed Something
      other things about a Constant Opportunity Cost of a Production Possibilities Frontier, PPF, or Curve PPC…

      So I believe you already understand that…
      A PPF w/Constant Opportunity Cost is a linear line, meaning the line is straight (not curved), and…

      •To be linear means the change between any two points anywhere on the line will be consistent.
      The Slope of any two points, is the same as the slope of any other two points.
      So it is constant because the slope is constantly the same.

      •Which means it's constantly the same opportunity cost no matter how many units you make of either item.

      Neither small batches nor bulk creation will change the opportunity cost, (make the y/x or PPF line differ).

      We will always give up the same amount of x to make a certain amount of y, or vice versa.

      •A PPF w/Constant Opportunity Cost indicates that the conditions are equally suited to make either product, so the resources are interchangeable!

      •A deeper look…
      (by example comparison)
      Since PPF displays the possible product combinations that can/could be made limited by finite resources (time, ingredients, labor, money, supply, whatever…), and…

      •Any core conditions change brings extra costs, to produce x that significantly differs from y will curve the line

      So the PPF will often be curved
      because frequently production of products differs in fundamental ways.

      Blankets to Flooring, both using eco-friendly bamboo and hemp fibers, but a different skill set, (required retraining costs: production time loss, skilled workers loss (from the other product), profit loss, and instructor pay, each taken from the finite total allocated for both x and y)…
      each changing the y/x balance,
      so the PPF line curves

      or transformation of materials (instead of spun fiber threads to weave, they need fine mulch to mold and emboss patterns)…
      so the PPF line curves

      •Without new investment, most x or y exchanges will curve the line, reflecting the higher opportunity cost of production differences…

      -Bulging out convex, an 'increasing opportunity cost' (for growing vexing issues), or…

      -Caving in concave, a 'decreasing opportunity cost' (for shrinking issues).

      •So resources need to be swappable for a Constant Opportunity Cost, (straight/linear PPF), to have no new costs, it does not have to be a one-to-one, just consistently the same quantities of y/x exchanged throughout production
      of either item.

      Perhaps a paper producer with very versatile automated machinery, is considering between: uncut paper rolls or pre-sliced sheets, or comparing different weights of paper (thinner to thicker), or legal to standard length, or posters to postcards…
      if they're still using the same skilled workers, materials, machines, etc
      the same y/x balance,
      the PPF is straight!

      Perhaps a chocolates creator considering between similar already producible products: bonbons to full bars, if they're using the same ingredients, the chocolatiers, the same tempering and cooling methods and technology, etc
      it keeps the y/x constant,
      the PPF is straight!

      •Therefore a Constant Opportunity Cost would more likely occur in an established production situation of similar possible products.

      When switching between x and y is just reallocating the 'what/where/how' conditions that are equally suited to create either potential product, the PPF is a straight line

      So in specialty fields, with superficial distinction between products, resources are interchangeable, so the Opportunity Cost stays the same constant price.

      For production purposes the only difference will be the quantity created of x or y

      (≧▽≦) I hope that helps someone!
      (3 votes)
  • hopper cool style avatar for user Jose Gelves Cabrera
    May someone explain me this example of costs?
    "When you head out to see a movie, the cost of that activity is not just the price of a movie ticket, but the value of the next best alternative, such as cleaning your room."
    (1 vote)
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    • male robot hal style avatar for user Enn
      In economics, cost also includes the opportunity cost. When you go out to see a movie the cost will also include the cost incurred by losing that time that something else(the next best alternative) could have been done. Here the time could have been utilized to clean your room and the loss of this time to instead see the movie results in the opportunity cost.
      (3 votes)
  • blobby green style avatar for user dvir.bartov1
    Hey, in the chocolate donuts factory that aren't using all its machines example.
    It is said that if they use all their mechines(but don't buy new ones), they use all their resources efficiently. However, isn't money considered a resource? If they have enough money to buy more machines but they aren't doing so for no good reason, isn't it considered an underutilization of resources?

    (2 votes)
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