Production Possibilities

Opportunity Cost

Every production decision results in an opportunity cost: the value or benefit of the best alternative given up.

Since the production possibility frontier provides the production points at which Jerry (an individual stranded on an isolated island) is maximizing his use of time, it also shows the trade-offs of producing a certain amount of each good. Suppose Jerry is being efficient and is producing at a point on the frontier. If he wants to catch one more fish, he has to give up time spent gathering bananas (and vice versa). This trade-off in moving between points along his production possibility frontier shows Jerry's opportunity cost in production. Opportunity cost is the value or benefit of the next best alternative given up when making a choice.

Jerry's PPF shows that in the same time that he can catch two fish, he could gather one bunch of bananas. His opportunity cost reflects that for every bit of additional time he spends catching fish, he has less time to spend gathering bananas. If Jerry's opportunity cost is constant (he doesn't face other costs like renting a boat, etc), every time he catches one more fish, he gives up gathering half of a bunch of bananas. By drawing a straight-line production possibility curve for Jerry, it is assumed he faces constant opportunity costs in his decision of how many fish and bunches of bananas to collect. It won't cost him more (he doesn't use a more expensive boat or pay rent on a banana harvesting tool) to catch fish. He will then catch fish and gather bananas based on how many of each he wants.

Jerry's Opportunity Cost

The production possibility frontier shows Jerry's opportunity cost, that is, what he must give up in order to produce something else. If Jerry is catching 10 fish and harvesting 15 bananas, and he wants to catch an additional 10 fish (20 fish total), he must give up harvesting 5 bananas. His opportunity cost to catch 10 additional fish is 5 bananas.
Opportunity costs do not always remain constant. At times opportunity costs can increase. This happens because of the use of resources for each good. For example, a plot of land may be used either to grow crops or graze cattle. When switching from grazing cattle to growing crops, there may be little opportunity cost. However, over time the land becomes less fertile, so less crops can be grown. When opportunity costs increase, the production possibility frontier becomes a concave (bowed out) curve. Increasing opportunity cost occurs when more resources need to be allocated to produce an additional unit of the good.

Jerry's Adjusted Production Possibility Frontier

The production possibility frontier changes when Jerry faces increasing opportunity cost. For example, if Jerry must spend more time gathering fish, his opportunity cost increases with each additional fish he catches.
Note that even with increasing opportunity cost, Jerry's maximum number of fish caught and his maximum number of bananas gathered are still the same because the endpoints of Jerry's production possibility frontier are determined by his available resources and technology, which remain the same. He can never gather more than 20 bananas, no matter how many fish he catches, because he doesn't have the resources to do that.

To further the example, at times Jerry's opportunity costs may increase. Because Jerry’s only resource is his time, anything that makes the collection of bananas or catching of fish more time intensive will affect his opportunity cost. For example, if Jerry needs to climb higher and higher to collect bananas from a tree, it will take more of his time to collect the same number of bananas as before, which takes away time he can spend fishing. If he must go further and further into the ocean to catch fish, he won’t be able to spend as much time collecting bananas. Now, instead of a straight line, Jerry's production possibility frontier is a bowed-out curved line, which illustrates his increasing opportunity cost.