Efficiency

All of our explanations up to now have implicitly assumed that the economy is producing efficiently that is, it is on, rather than inside, the production possibility frontier. Remember that efficiency means that the economy’s resources are being used as effectively as possible to satisfy people’s needs and desires.One important aspect of overall economic efficiency is productive efficiency.

Productive efficiency occurs when an economy cannot produce. more of one good without producing less of another good; ~his implies that the economy is on its production-possibility frontier.

Let’s see why productive efficiency requires being on the PPF. Start in the situation shown by point.

D in Figure 1-2. Say the market calls for another ‘million pounds of butter. If we ignored the constraint shown by the PPF. we might think it possible to produce more butter without reducing gun production. say. by moving to point 1. LO the right
of point D, But point I is outside the frontier. in the “in feasible” region. Starling from D, we cannot get more butter with out giving up some gun. Hence point J) displays productive efficiency, while point is in feasible.

One further point about productive efficiency ,can be illustrated using till” PPF: !icing on the PPF means that producing more of one good inevitably requires sacrificing other goods. When we produce more guns. we are substituting Kills for butter, Substitution is the law of life in a full-employment economy)’and the production-possibility frontier depicts the menu of society’s choices,

Unemployed Resource. and Inefficiency. Even casual observers of modern life know that society ha unemployed resources in the form of idle workers.idle factories. and idled land. When there are Unemployed resources. the economy is not on its production-possibility frontier at all but. rather. some where inside it. In Figure 1-2. point U represents a:point inside the PPF; at U, society is producing only 2 units of butter and finalists of guns. Some resources are unemployed. and, by putting them to work. we can increase our output of all goods; the economy can move from U to D. producing more hunter and more guns. thus improving the economy efficiency, \ft’ can have our guns and eat more butter too.

One source of inefficiency occurs during business cycles. From 1929 to 193~. in the Great Depression.the total output produced in the United States declined by almost 25 percent. This occurred not because the PPF shifted in hill because various shocks reduced spending and pushed the economy inside its PPF. Then the’ buildup for World War II ex paneled demand. .and output “~n’\\’ rapidly as the economy”1 pushed back to the PPF .Similar forces were at work in much of the industrial! world between 1990 and 1996 as macroeconomic pushed Europe and japan inside then PPFs.

Business-cycle depressions are not the only real son when an economy might be inside its PPF. One of the most dramatic declines in production occurred during the earl}’ 19905 after countries threw off their socialist planning systems and adopted free markets, Because of the disruptions to organizations and production patterns. output fell and unemployment rose as firms responded to changing markets and the new rules of capitalism. No period of peacetime history saw such sustained declines in output as the real business cycles” of the post-socialist economies.

However, economist’ expect”ct that this downturn will he but .a temporary setback. Already. the economies that have made the most thorough reforms-such as Poland and the Czech Republic-shave turned the corner and art.’ beginning to recover.Their PPF are once again shifting outward and their income are likely to surpass the incomes or’ countries like Ukraine or Belarus, which have been reluctant reformers. ‘

As we close this introductory chapter; Jet us return briefly to our opening theme. Why study economy? Perhaps the best answer to the question is a famous one given by Keynes in the final tine of The Genera Employment, Interest and Money)’:

The ideas of economists and political philosophers, both when they are right and when ‘they are wrong. are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men. who believe themselves to be’ quite exempt from am’ intellectual influences, arc usually the . slaves of some defunct economist. Madmen .in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not. indeed. immediately, but after a certain interval; for in the field (,f economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age. 50 that the ideas which civil servants and politicians and even agitator apply to current .event are not likely to be the newest .But soon or late, it is ideas , not vested inn-rests. which are dangerous for good or evil.

To understand how the powerful ideas of economics apply to the central issues of human societies ultimately. this is why we study economics.

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