Decisions, Decisions, Decisions: Opportunity Cost and PPF Explained
How you spend every moment of every day is determined by you, and the choices that you make. Choices can range from small, often trivial decisions — such as which shirt to wear in the morning, to career defining moments. Whether you realize it or not, each decision you make has implications. To further explore what this means, let’s take a look at one of the most fundamental concepts of economics: Opportunity cost.
What is it?
Opportunity cost refers to the “effect” of any decision you make, exploring what you are GIVING UP by choosing an alternate pathway or choice. Simply put, opportunity cost is another form of explaining the loss of potential gain from another possible, yet not chosen alternative.
Let’s break this down. For example, Steve is a current University student. He has an economics test tomorrow, but his friend is also throwing a birthday party tonight. What should he do?
Steve can only be in one place at once. Ultimately, this means that he will have to choose between devoting his presence to studying at home for his test, or attending the birthday party. He has a limited amount of time, which is the resource being used in this situation.
Though there is no right answer for Steve, each choice implies various effects. Let’s assume that he decides to study for the test. The opportunity cost in this situation, exploring what he is GIVING UP, is the time and fun he could be spending at the party. It evaluates the consequences of choosing one item over the other.
The Production Possibilities Curve/The Production Possibilities Frontier
The economic reasoning behind opportunity cost can be examined with the use of a Production Possibilities Frontier (PPF). In another example, let’s say that you have the ability to produce 2 resources, wheat and cotton. Recall that you have a limited amount of each, and are not able to produce infinite amounts of each resource because of it. In order to visualize what this looks like, economists use what is known as a Production Possibility Frontier (PPF) in order to evaluate how we can maximize production. The curve itself (see blue line) represents the maximum amount of resources. Anything within the curve represents production that is attainable, but NOT an efficient use of resources (your limited resources would still be able to generate more). However, anything BEYOND the curve represents what would be a wonderful use of resources, yet is unattainable with those we have.
As you move across the x and y-axis, economics are able to determine maximum values for each of the resources.
The decisions that we make on a day to day basis have effects, however major or minor. Anything we gave up or what is lost due to choosing one item over another is known as opportunity cost. In order to maximize any two, non-related resources, one can use the Production Possibilities Frontier to determine the greatest output.
So, the next time you make a choice — consider the opportunity cost. This can often be a helpful tool when it comes to decision making, in accordance with the PPF.
