Production Possibility Frontier (PPF)

ECO 201 Cram Kit Bundle Opportunity Cost & PPF Production Possibility Frontier (PPF)

Before we start, it is important to note:

The Production Possibilities Frontier (PPF) is the same exact thing as the Production Possibilities Curve (PPC).

(Depending on the professor, they may call it different names.)

Starting with scarcity

Scarcity which refers to the limited nature of society's resources.

Our society does not have unlimited resources which means that we must make decisions with how limited resources are used.

Here inlies the value of PPF curves!

A PPF is a line or curve on a graph showing the maximum attainable combinations of two, scarce goods.

Creating a PPF curve

Example: Imagine you're a bartender at Study Street Bar & Grille and you serve 2 drink specials on Thursday nights. Both specials use the same type of vodka, and you only have one handle left. You can either use all of the vodka to make 20 vodka sodas or use all of the vodka to pour 40 lemon drop shots.

Vodka is the limited resource here: we only have 1 handle and now we are faced with the decision of how to use the vodka.

Define your axes

A PPF graphs out this scenario and shows the different combinations of the two drinks that we can make. On each axis will be one of the drinks (the good we produce in this scenario).

The maximum value on each axis is the number of units we can produce if we devote all our resources (one handle of vodka) to it.

We can see these maximum values here:

In other words, if we make 0 lemon drop shots, that means we can make 20 vodka sodas. On the flip side, if we make 0 vodka sodas, that means we can make 40 lemon drop shots.

Determine slope of PPF

Essentially, we need to determine how much of 1 vodka soda we'd have to give up in order to make "X" amount of lemon drops.

To determine the slope of your PPF, ask yourself: How many of Good A you’d need to give up to get one of Good B?

If you remember from mathematics, here's the equation for slope...

slope = (y₂ - y₁) / (x₂ - x₁)

For (x₁, y₁), we'll make this the point representing the max vodka sodas you could make. That occurs at (0, 20).

slope = (y₂ - y₁) / (x₂ - x₁)
slope = (y₂ - 20) / (x₂ - 0)

For (x₂, y₂), we'll make this the point representing the max vodka sodas you could make. That occurs at (40, 0).

slope = (y₂ - y₁) / (x₂ - x₁)
slope = (0 - 20) / (40 - 0)

When we solve this, we get a slope of -1/2!

slope = (y₂ - y₁) / (x₂ - x₁)
slope = (0 - 20) / (40 - 0)
slope = -20 / 40
slope = -1/2

What does this mean?

In relation to opportunity cost, we can understand it like so:

Opportunity Cost = What’s Lost / What’s Gained
Opportunity Cost = -1 vodka soda / 2 lemon drops

For example, if we lost one vodka soda (going from 20 to 19), that means we gain 2 lemon drops (going from 0 to 2)!

If we lost another vodka soda (going from 19 to 18), that means we gain 2 more lemon drops (going from 2 to 4)!

This process of losing 1 vodka soda for 2 lemon drops continues down the rest of our PPF line!

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