pcecon.com Class Notes
by


Resource use Decisions

One of the kinds of decisions to which we can apply the concepts of chapter 2 is the use of resources, such as a the time of workers.

The following example is based on questions 3.16 to 3.23 in the Study Guide:
Suppose you are managing the time of a worker, named Larry. The abilities of a producer (a country, a factory, or a person) to produce goods from resources is called its production possibilities. Suppose that a few of Larry's daily production possibilities for making two goods, "narf" and "zort," could be summarized in a table, like that below:

Narf
Zort
0
70
1
69 2/3
30
60
60
50
90
40
120
30
150
20
180
10
207
1
210
0

These are just some of the possibilities (to save space). Another description of this is that Larry could produce 210 narf OR 70 zort, OR something in between.

Making decisions requires that we understand something about opportunity cost.
What is the marginal opportunity cost of getting Larry to produce one zort?

Marginal opportunity cost of making one more zort is the number of narfs that are given up to make one zort. This is the difference (change, increment) in the number of narfs produced as one more zort is made.

Each zort Larry makes means he cannot spend that time making narfs. In one day, he could make 70 zort, so he uses 1/70 of a day to make one zort. He could make 210 narfs in a day, so in the 1/70 of a day, he could have been making 210x1/70 narfs, which is 3 narfs.

You could also find the change in number of narfs divided by the change in zorts
210 narfs/70 zorts
=3 narfs per zort

Or, given that 210 narfs=70 zorts, find out how many narfs one zort is equal to. Dividing both sides by 70 gives 3 narfs.

What is the marginal opportunity cost of getting Larry to make one narf?

Marginal opportunity cost of making one more narf is the number of zorts that are given up to make one narf. This is the difference (change, increment) in the number of zorts produced as one more narf is made.

Each narf Larry makes means he cannot spend that time making zorts. In one day, he could make 210 narfs, so he uses 1/210 of a day to make one narf. He could make 70 zorts in a day, so in the 1/210 of a day, he could have been making 70x1/210 zorts, which is 1/3 of a zort.

You could also find the change in number of zorts divided by the change in narfs
70 narfs/210 zorts
=1/3 zorts per narf

Or, given that 210 narfs=70 zorts, find out how many zorts one narf is equal to. Dividing both sides by 210 gives 1/3 zort.

Making decisions about one resource (person) is sort of limited, so let's suppose that another worker also can make narfs and zorts!

Maurice could make 160 narfs or 40 zorts (or something in between).

What is the cost of having Maurice make one zort?

Marginal opportunity cost of making one more zort is the number of narfs that are given up to make one zort. This is the difference (change, increment) in the number of narfs produced as one more zort is made.

Each zort Maurice makes means he cannot spend that time making narfs. In one day, he could make 40 zort, so he uses 1/40 of a day to make one zort. He could make 160 narfs in a day, so in the 1/40 of a day, he could have been making 160x1/40 narfs, which is 4 narfs.

You could also find the change in number of narfs divided by the change in zorts
160 narfs/40 zorts
=4 narfs per zort

Or, given that 160 narfs=40 zorts, find out how many narfs one zort is equal to. Dividing both sides by 40 gives 4 narfs.

What is the cost of having Maurice make one narf?

Marginal opportunity cost of making one more narf is the number of zorts that are given up to make one narf. This is the difference (change, increment) in the number of zorts produced as one more narf is made.

Each narf Maurice makes means he cannot spend that time making zorts. In one day, he could make 160 narfs, so he uses 1/160 of a day to make one narf. He could make 40 zorts in a day, so in the 1/160 of a day, he could have been making 40x1/160 zorts, which is 1/4 of a zort.

You could also find the change in number of narfs divided by the change in zorts
40 zorts/160 narfs
=1/4 zorts per narf

Or, given that 160 narfs=40 zorts, find out how many zorts one narf is equal to. Dividing both sides by 160 gives 1/4 of a zort.

Putting them together, Larry could produce 210 narf OR 70 zort, OR something in between. Maurice could make 160 narfs or 40 zorts (or something in between).

Suppose we want 120 narfs and as many zorts in addition. We want to get the most we can get of zorts, given that we want 120 narfs.
Another way to say this is that we want to use the resources in an
efficient way. Efficiency just means getting as much as we can. How do we do it???

Two methods of using our resources might be suggested:

OPTION 1
Larry makes 120 narfs. He'll have enough of the day left over to also produce 30 zorts.
Maurice makes only zorts (since Larry is making all the narfs we need), so he makes 40 zorts.
This results in 120 narfs and 70 zorts, in total.

OPTION 2
Maurice makes 120 narfs. He'll have enough time left over to also produce 10 zorts.
Larry makes only zorts (since Maurice is making all the narfs we want), so he makes 70 zorts.
This results in 120 narfs and 80 zorts, in total.

The second option is more efficient, because it results in more zorts being produced, but no fewer narfs being made than the first option. We could say that the first option is inefficient, since it results in less than the most output or production possible.

An option is more efficient than another if it results in more of one good being produced, without less of some other good being produced.

One key to picking the efficient method of producing something is to pay attention to opportunity cost. In production, this means you pick the lowest cost way of getting what you want to produce. What do we call this behavior?

Economizing, Economization
The terms efficiency and economizing are related, but mean different things.
Efficient means you end up with the most.
Economizing means the way of doing things that requires you to give up the least.

If you get the lowest cost producer (resource) to produce the thing they produce at lowest cost, then you end up with the most being produced.
In other words, if you economize, you’ll be efficient.

The law that says this will occur is the
law of comparative advantage
. To remember what it means, think of it as the law of cost advantage (comparative and cost both begin with "co").
In general, a producer is said to have a comparative advantage in making or doing something if that producer can make that good or perform that service at lower cost than other producers can.

In our example, Maurice has a comparative advantage in producing narf.

Adding another producer, Pinky to the mix gives us the following:


Larry could produce 210 narfs OR 70 zorts, OR something in between.
(so his costs are 1 zort costs 3 narfs and 1 narf costs 1/3 of a zort)

Maurice could produce 160 narfs or 40 zort or something in between
(so his costs are 1 zort costs 4 narfs and 1 narf costs 1/4 of a zort)

Pinky could produce 50 narfs or 25 zorts or something in between
(so his costs are 1 zort costs 2 narfs and 1 narf costs 1/2 of a zort)

With all three producers, the comparative advantage in producing narfs remains with Maurice, but Pinky has a comparative advantage in producing zort (he can do it at lowest cost). This means that any zort we want produced should be produced by Pinky first (before we get anyone else to do it). Larry (whose cost of producing zorts is second-lowest) would be our second choice for producing zorts (if we want more than Pinky can make).

Maurice should produce narfs first, before we seek narfs from any other producers. Larry, whose cost is second-lowest, should be our second choice of producers for making narfs.

While we can make such rules when one person is telling the producers what to do, how do such decisions get made in the "real world?"

Suppose Larry, Maurice and Pinky each open shops, in which they sell narfs and zorts. Most of the time, people just want narfs. Once in a while, some people will buy a zort. Suppose you are the only person today who wants to buy a zort.
Normally all narfs sell for $1 every day.

Maurice will be willing to make a zort if you pay him at least
$4 (because that is how much money he could get for the narfs he could produce with the same amount of time)
The lowest price Larry would be willing to sell you a zort for is
$3 (again, because he could earn that much making narfs)
The lowest price at which Pinky would be willing to sell a zort is
$2.

Consumers who economize will find that Pinky will make a zort for less money than anyone else, and will seek him out first for any zorts that they want. No central authority, manager or organizer is needed to assure that comparative advantage will be the basis for determining who ends up making the zorts. It is only necessary that each producer has some understanding of his own relative costs, and that this is reflected in the prices quoted to consumers.
Pinky will end up making nothing but zorts, or makes all the zorts that get made. Thus, he is concentrating on zorts.
This concentration on doing a particular job or being the main producer of a thing is called
specialization or
division of labor

You may be worried about Larry. After all, of the three producers, he can make more zorts or narfs than anyone. The ability to produce more than anyone else is called an absolute advantage. Since Larry can produce more narfs in a day than anyone, Larry has an absolute advantage in producing narfs. He also can produce more zorts in a day than anyone else, so he has an absolute advantage in producing zorts as well. Absolute advantage does not tell us who will produce which good or perform which task. It does indicate that a producer might make more money than other producers (because he or she will make more product to sell or perform more services that consumers value).

Copyright 2004 by Ray Bromley. Permission to copy for educational use is granted, provided this notice is retained. All other rights reserved. Copyright 2006 by Ray Bromley. For economics information, and other information about Ray Bromley, visit www.raybromley.com. Permission to copy for educational use is granted, provided this notice is retained. All other rights reserved.
Send comments or suggestions to