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 ...
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- Spring '08