raybromley.com Class Notes
by Ray Bromley

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 T3.11a to T3.11e in the Study Guide (11 in the text):
Suppose you are managing the time of a worker, named Bianca. 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 Bianca's daily production possibilities for making two goods, "paper records" and "computer files," could be summarized in a table, like that below:

These are just some of the possibilities (to save space). Another description of this is that Bianca could produce 150 paper records OR 75 computer files, OR something in between.

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

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

Each computer file Bianca makes means she cannot spend that time making paper records. In one day, she could make 75 computer files, so she uses 1/75 of a day to make one computer file. She could make 150 paper records in a day, so in the 1/75 of a day, she could have been making 150x1/75 paper records, which is 2 paper records.

You could also find the change in number of paper records divided by the change in computer files
150 paper records/75 computer files
=2 paper records per computer file

Or, given that 150 paper records=75 computer files, find out how many paper records one computer file is equal to. Dividing both sides by 75 gives 2 paper records.

What is the marginal opportunity cost of getting Bianca to make one paper record?

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

Each paper record Bianca makes means she cannot spend that time making computer files. In one day, she could make 150 paper records, so she uses 1/150 of a day to make one paper records. She could make 75 computer files in a day, so in the 1/150 of a day, he could have been making 75x1/150 computer file, which is 1/2 of a computer file.

You could also find the change in number of computer files divided by the change in paper records
75 paper records/150 computer files
=1/2 computer file per paper records

Or, given that 150 paper records=75 computer files, find out how many computer files one paper record is equal to. Dividing both sides by 150 gives 1/2 computer file.

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

Steven could make 120 paper records or 40 computer files (or something in between).

What is the cost of having Steven make one computer file?

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

Each computer file Steven makes means he cannot spend that time making paper records. In one day, he could make 40 computer files, so he uses 1/40 of a day to make one computer files. He could make 120 paper records in a day, so in the 1/40 of a day, he could have been making 120x1/40 paper records, which is 3 paper records.

You could also find the change in number of paper records divided by the change in computer files
120 paper records/40 computer files
=3 paper records per computer file

Or, given that 120 paper records=40 computer files, find out how many paper records one computer file is equal to. Dividing both sides by 40 gives 3 paper records.

What is the cost of having Steven make one paper record?

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

Each paper record Steven makes means he cannot spend that time making computer files. In one day, he could make 120 paper records, so he uses 1/120 of a day to make one paper record. He could make 40 computer files in a day, so in the 1/120 of a day, he could have been making 40x1/120 computer files, which is 1/3 of a computer files.

You could also find the change in number of paper records divided by the change in computer files
40 computer files/120 paper records
=1/3 computer files per paper records

Or, given that 120 paper records=40 computer files, find out how many computer files one paper records is equal to. Dividing both sides by 120 gives 1/3 of a computer files.

Putting them together, Bianca could produce 150 paper records OR 75 computer files, OR something in between. Steven could make 120 paper records or 40 computer files (or something in between).

Suppose we want 120 paper records and as many computer files in addition. We want to get the most we can get of computer files, given that we want 120 paper records.
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
Bianca makes 120 paper records. She'll have enough of the day left over to also produce 15 computer files.
Steven makes only computer files (since Bianca is making all the paper records we need), so he makes 40 computer files.
This results in 120 paper records and 55 computer files, in total.

OPTION 2
Steven makes 120 paper records. He'll have no time left over to also produce computer files.
Bianca makes only computer files (since Steven is making all the paper records we want), so she makes 75 computer files.
This results in 120 paper records and 75 computer files, in total.

The second option is more efficient, because it results in more computer files being produced, but no fewer paper records 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, Steven has a comparative advantage in producing paper records.
Bianca has a comparative advantage in doing the computer files.

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

Bianca could produce 150 paper records OR 75 computer files, OR something in between.
(so her costs are 1 computer files costs 2 paper records and 1 paper records costs 1/2 of a computer file)

Steven could produce 120 paper records or 40 computer files or something in between
(so his costs are 1 computer files costs 3 paper records and 1 paper records costs 1/3 of a computer file)

Paula could produce 100 paper records or 25 computer files or something in between
(so her costs are 1 computer files costs 4 paper records and 1 paper records costs 1/4 of a computer files)

With all three producers, the comparative advantage in producing computer files remains with Bianca, but Paula has a comparative advantage in producing paper records (she can do it at lowest cost). This means that any computer files we want produced should be produced by Bianca first (before we get anyone else to do it). Steven (whose cost of producing computer files is second-lowest) would be our second choice for producing computer files (if we want more than Bianca can make).

Paula should produce paper records first, before we seek paper records from any other producers. Steven, whose cost is second-lowest, should be our second choice of producers for making paper records. Bianca should only be put to work doing paper records if we desire more of them than Paula and Steven (combined) can do.

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 Bianca, Steven and Paula charge for each paper record and computer file they provide. Most of the time, people who hire them just want paper records. Once in a while, some people will pay them for a computer file.
Normally, the going price to have anyone produce a paper record is $.50 (fifty cents) every day.

Paula will be willing to do a computer file only if you paid her
$2 (because that is how much money she could get for the paper records she could produce with the same amount of time)
The lowest price Steven would be willing to do a computer file for is
$1.50 (again, because he could earn that much doing paper records in the same amount of time)
The lowest price at which Bianca would be willing to do a computer file is
$1.

Consumers who economize will find that Bianca will produce a computer files for less money than anyone else, and will seek her out first for any computer files 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 computer records (and, by extension, paper records). It is only necessary that each producer has some understanding of her or his own relative costs, and that this is reflected in the prices quoted to consumers.
Bianca will end up producing only computer records, or produces all of the computer records that get made. Thus, she is concentrating on computer files.
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 Bianca. After all, of the three producers, she can make more paper records or computer files than anyone. The ability to produce more than anyone else is called an absolute advantage. Since Bianca can produce more computer files in a day than anyone, Bianca has an absolute advantage in producing computer files. She also can produce more paper records in a day than anyone else, so she has an absolute advantage in producing paper records 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).