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.
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.
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 concave to the origin and also linear, but it can never be convex. The third property implies that the slope of PPF indicates the opportunity cost between two goods. The linear frontier shows that the country faces a constant opportunity cost between the two products (Nicholson & Snyder, 2011). However, in this case, the country can manufacture much of a product by sacrificing only a little amount of the other product. On the other hand, if the frontier is concave to the origin then it indicates that the economy has an increasing opportunity cost. It reflects that as the production of particular goods increases within the international market, its opportunity cost of producing another unit increases (Krugman, 2008).
Figure 1: Concave PPF
(Source: Krugman, 2008)
Nonetheless, with the help of PPF it can be shown that trade is helpful for both the countries so that they can consume more goods as compared to the situation when there is no trade agreement between the countries. For example, the society has the choice to make an investment on two things that is education and housing (Companys & McMullen, 2007). The PPF in this situation is concave to the origin indicating an increasing opportunity cost (Nicholson & Snyder, 2014). This indicates that the opportunity cost of education varies with respect to the housing and the main reason behind this is that some of the resources are better suitable for education as compared to housing and the situation can be other way round.