3 (10) - CHAPTER 2 ECONOMIC MODELS TRADE-OFFS AND TRADE But...

Info icon This preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
Image of page 1
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: CHAPTER 2 ECONOMIC MODELS: TRADE-OFFS AND TRADE But suppose that for some reason Tom was at point C. producing 20 fish and 9 coconuts. Then this one-perSon economy would definitely not be efficth in produc- tion. and would therefore be inefficient: it could be producing more of both goods. Another example of this occurs when people are involuntarily unemployed: they want to work but are unable to find jobs. When that happens. the economy is not efficient in production because it could be producing more output if these people were employed. Although the production possibility frontier helps clarify what it means for an economy to be efficient in production. it’s important to understand that efficiency in production is only part of what’s required for the economy as a whole to be efficient. Efficiency also requires that the economy allocate its resources so that consumers are as well off as possible. If an economy does this. we say that it is efl’icient in allocation. To see why efficiency in allocation is as important as efficiency in production. notice that points A and B in Figure 2-1 both represent situations in which the economy is efficient in production. because in each case it can’t produce more of one good with- out producing less of the other. But these two situations may not be equally desirable. Suppose that Tom prefers point B to point A—that is. he would rather consume 28 fish and 9 coconuts than 20 fish and 15 coconuts. Then point A is inefficient from the point of view of the economy as a whole: it’s possible to make Tom better off without making anyone else worse off. (Of course, in this castaway economy there isn't anyone else: Tom is all alone.) This example shows that efficiency for the economy as a whole requires both effi- ciency in production and efficiency in allocation: to be efficient. an economy must produce as much of each good as it can given the production of other goods. and it must also produce the mix of goods that people want to consume. In the real world. command economies. such as the former Soviet Union. were notorious for inefficien- cy in allocation. For example, it was common for consumers to find a store stocked with a few odd items of merchandise. but lacking such basics as soap and toilet paper. Opportunity Cost The production possibility frontier is also useful as a reminder of the fundamental point that the true cost of any good is not just the amount of money it costs to buy. but everything else in addition to money that must be given up in order to get that good—the opportunity cost. If. for example. Tom decides to go from point A to point 3. he will produce 8 more fish but 6 fewer coconuts. So the oppor- tunity cost of those 8 fish is the 6 coconuts not gathered. Since 8 extra fish have an opportunity cost of 6 coconuts. each 1 fish has an opportunity cost of 6/3 = 3/4 of a coconut. Is the opportunity cost of an extra fish in terms of coconuts always the same. no matter how many fish Tom catches? In the example illustrated by Figure 2-1, the answer is yes. If Tom increases his catch from 28 to 40 fish. the number of coconuts he gathers falls from 9 to zero. So his opportunity cost per additional fish is 9/12 = 3/4 of a coconut. the same as it was when he went from 20 fish caught to 23. However. the fact that in this example the opportunity cost of an additional fish in terms of coconuts is always the same is a result of an assumption we’ve made. an assumption that's reflected in how Figure 2-1 is drawn. SpecificallyI whenever we assume that the opportunity cost of an additional unit of a good doesn't change regardless of the out- put mix. the production possibility frontier is a straight line. Moreover. as you might have already guessed, the slope of a straight-line produc- tion possibility frontier is equal to the opportunity cost—specifically. the opportunity cost for the good measured on the horizontal axis in terms of the good measured on the vertical axis. In Figure 2-1. the production possibility frontier has a constant slope of —3/4. implying that Tom faces a constant opportunity cost for ‘1 fish equal to 3/4 of a coconut. (A review of how to calculate the slope of a straight line is found in this chapter's appendix.) This is the simplest case. but the production possibility frontier model can also be used to examine situations in which opportunity costs change as the mix of output changes. 27 ...
View Full Document

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern