OPPORTUNITY COST AND PRODUCTION POSSIBILITY FRONTIER

OPPORTUNITY COST AND PRODUCTION POSSIBILITY FRONTIER 1
Opportunity Cost and Production Possibility Frontier
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OPPORTUNITY COST AND PRODUCTION POSSIBILITY FRONTIER 2
Abstract
The purpose of this paper is to examine the relationship between opportunity cost and
production possibility frontier. The study will offer an opportunity to understand the concept of
‘production possibility frontier’ and carry out a market analysis. 
OPPORTUNITY COST AND PRODUCTION POSSIBILITY FRONTIER 3
Introduction
The main problem that the firms face is that of the scarcity of the resources that would in
turn affect the production of goods and services. The production on the other hand affects the
consumption decisions and rise in consumption of a particular product reduces the consumption
of another product (Farole, Rodriguez‐Pose & Storper, 2011). However, there is an opportunity
cost associated with the financial decisions within the organizations. The firms choose the best
alternative which would offer them with a high profit in the international market (Afonso,
Schuknecht & Tanzi, 2005). The production decisions are to be made by the firms and the
production possibility frontier is considered as a boundary between the combinations of the
goods and services to be produced and the other combination that cannot be produced (Chavas,
Petrie & Roth, 2005).
The production possibility frontier demonstrates the existence of an opportunity cost in
the business that the producers can avail in order to earn a high profit. However, if the firms
produce on the frontier it implies that the resources of the firms are fully utilized and if the
combination of goods lies below the frontier, the resources are said to be underutilized (Farole,
Rodriguez‐Pose & Storper, 2011). Therefore, the aim of this research is to determine the
relationship between opportunity cost and production possibility frontier. The study would
provide a scope to understand the concept of ‘production possibility frontier’ and carry out a
market analysis.
OPPORTUNITY COST AND PRODUCTION POSSIBILITY FRONTIER 4
Definition of Opportunity Cost
The concept of opportunity cost according to the economists considers the next highest
valued alternative that the individual can choose in order to earn a higher profit (Farole,
Rodriguez‐Pose & Storper, 2011). The concept is valid for the firms as well. It implies that the
individuals and firms are free to choose the next alternative that would provide them with greater
satisfaction. The opportunity cost is considered by the firms when there is scarcity of resources
in the economy that hampers the production process. The firms prefer to choose the production
of a different commodity in order to avoid slowdown in their growth rate (Farole,
Rodriguez‐Pose & Storper, 2011). Hence, the study shows that opportunity cost affects the firm’s
decision making process and the managers can undertake strategies to earn a higher level of
satisfaction.
The producers undertake the allocation of resources based on the opportunity cost which
indicates that the producers change their production process as well as the goods that they
manufacture. The concept of opportunity cost refers to the the producers can choose to
manufacture goods that are on high demand in the international market. According to the
researchers, in case the producers manufacture goods that meet the rising demands from the
customers, the company would earn a higher profit and set up its business successfully in the
international market (Farole, Rodriguez‐Pose & Storper, 2011). For example, a firm is in
financial distress and is facing a situation of loss in the international market; it would be able to
save itself by identifying the next best alternative of running the business that is, the firm’s
opportunity cost is expected to save the firm from going bankrupt.
OPPORTUNITY COST AND PRODUCTION POSSIBILITY FRONTIER 5
Relationship between Opportunity Cost and the PPF
In case if the firm faces a loss or there is scarcity of resources within the economy, the
firm is free to choose the production of some other goods for which there are abundant quantity
of raw materials found within the economy (Acemoglu, Aghion & Zilibotti, 2006). The fact of
choosing the next best alternative by the firms would provide them with greater level of
satisfaction is known as the opportunity cost. On the contrary, the PPF is a path in the economy
that shows the maximum possibility of producing goods and services with available resources
and technology. This path is called as the production possibility frontier (PPF). The PPF has
different properties that the study indicates. One of the properties says that all PPFs are
downward sloping that implies that the country needs to sacrifice one commodity in order to
produce more of the other commodity (Companys & McMullen, 2007). The frontier is usually
c 


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