Scarcity, choice and opportunity cost, the factors of production, and how a PPF shows efficient, inefficient and unattainable output and rising opportunity cost.
In February 2025 the UK government announced it would raise defence spending to 2.5% of GDP by 2027. To pay for it, it cut overseas aid from 0.5% to 0.3% of national income. The Prime Minister told Parliament it was a hard choice.
Every choice like this has a cost: not in money, but in what you give up. Economists call it opportunity cost.
Source: Prime Minister’s statement to the House of Commons (25 February 2025).
The economic problem: wants are unlimited, but the resources to satisfy them are scarce. So every society must choose what to produce, how to produce it and for whom.
The resources are the factors of production: land (natural resources), labour (human effort), capital (man-made tools, machines and buildings) and enterprise (organising the others and taking risks).
Opportunity cost is the value of the next best alternative given up when a choice is made.
A production possibility frontier (PPF) shows the maximum combinations of two goods an economy can produce with all its resources fully and efficiently used, with technology held constant.
The government decides to spend more on defence.
It does not raise taxes or borrow more to pay for it.
What must happen?
With limited resources, more of one thing means less of another. In February 2025 the UK government announced it would raise defence spending and pay for it by cutting overseas aid. What is given up is the opportunity cost.
This economy makes two kinds of goods: capital goods, such as machines, and consumer goods, such as food and phones. Using everything on capital goods gives 10; everything on consumer goods gives 10. The curve shows every efficient combination in between.
Any point on the curve is productively efficient: all resources are used. A point inside, like U, means some resources are unemployed or wasted. A point outside, like Z, is unattainable with current resources and technology.
Move along the frontier from A to B: consumer goods rise from 6 to 8 and capital goods fall from 8 to 6. The opportunity cost of those 2 consumer goods is the 2 capital goods given up.
Check: The economy moves from A (6 consumer, 8 capital) to B (8 consumer, 6 capital). What is the opportunity cost of the extra consumer goods?
Capital goods fall from 8 to 6: 2 capital goods given up for 2 more consumer goods.
Now make the same move again, further down the curve: from B to C, another 2 consumer goods. This time capital goods fall from 6 to 0. The same 2 extra consumer goods now cost 6 capital goods, three times as much as between A and B. That is increasing opportunity cost, and it is why the PPF bows outwards.
Check: Now the economy moves from B (8 consumer, 6 capital) to C (10 consumer, 0 capital). What is the opportunity cost of these 2 extra consumer goods?
Capital goods fall from 6 to 0: 6 capital goods given up for the same 2 extra consumer goods that cost only 2 between A and B.
Notice the curve is bowed outwards. The first 6 consumer goods cost only 2 capital goods. The next 2 cost 2 more. The last 2 cost 6. Opportunity cost rises as we specialise, because resources are not equally good at making both goods: the last workers and machines moved are the ones best suited to capital goods.
If resources were equally good at making both goods, the opportunity cost would be the same everywhere and the PPF would be a straight line. In exams, draw the bowed-out curve unless told otherwise.
Check: A PPF that is a straight line shows:
Each extra unit of one good costs the same amount of the other: resources are equally suited to both.
A point inside the PPF is productively inefficient: resources are unemployed or wasted, so more of both goods could be produced. Only points on the frontier are productively efficient.
Using a PPF diagram, explain the concept of opportunity cost.
Opportunity cost is the value of the next best alternative given up when a choice is made. Because resources are scarce, producing more of one good means producing less of another.
[Diagram: a PPF between capital goods and consumer goods, bowed outwards, with points A (6, 8), B (8, 6) and C (10, 0) marked and arrows along the curve.]
A production possibility frontier shows the maximum combinations of two goods an economy can produce when all its resources are fully and efficiently used. Moving along the frontier from A to B, the output of consumer goods rises from 6 to 8, but the output of capital goods falls from 8 to 6. The opportunity cost of the extra 2 consumer goods is the 2 capital goods given up.
Because the PPF is bowed outwards, the opportunity cost rises as more consumer goods are produced: resources are not equally suited to both goods, so ever more capital goods must be given up for each extra consumer good.
Defence and aid spending: UK Government statement to Parliament (25 February 2025). Diagrams drawn with Rough.js and perfect-freehand, both MIT licensed. Your answers are saved only on this device.