21.3) This is so because at U the economy will be under-employing its resources and H is beyond the resources available. For example, the combined output of the two goods can neither be at U nor H. It is to be remembered that all the points representing the various reduction possibilities must lie on the production possibility curve AF and not inside or outside of it. The production possibility curve is also called transformation curve, because when we move from one position to another, we are really transforming one good into another by shifting resources from one use to another. In this diagram AF is the production possibility curve, also called or the production possibility frontier, which shows the various combinations of the two goods which the economy can produce with a given amount of resources. The following diagram (21.2) illustrates the production possibilities set out in the above table. This is due to the basic fact that the economy’s resources are limited. This means that, in a full-employment economy, more and more of one good can be obtained only by reducing the production of another good. As we move from A to F, we sacrifice increasing amounts of cotton. At B, the economy can produce 14,000 quintals of wheat and 1000 quintals of cotton.Īt C the production possibilities are 12,000 quintals of wheat and 200u quintals of cotton, as we move from A to F, we give up some units of wheat for some units of cotton For instance, moving from A to B, we sacrifice 1000 quintals of wheat to produce 1000 quintals of cotton, and so on. RAND quickly backpedaled on the study, and instead moved to a more cautious approach which spelled out a range of choices: for example, some choices might cost more in money but be expected to have fewer deaths, while other choices might cost less in money but be expected to have more deaths. These are the two extremes represented by A and F and in between them are the situations represented by B, C, D and E. If, on the other hand, all available resources are utilized for the production of cotton, 5000 quintals are produced. It all available resources are employed for the production of wheat, 15,000 quintals of it can be produced. The following table gives the various production possibilities. We suppose that the productive resources are being fully utilized and there is no change in technology. Let us suppose that the economy can produce two commodities, cotton and wheat. If it is decided to produce more of certain goods, the production of certain other goods has to be curtailed. In other words, the economy has to choose which goods to produce and in what quantities. The productive resources of the community can be used for the production of various alternative goods.īut since they are scarce, a choice has to be made between the alternative goods that can be produced. As such, Pareto efficiency may sometimes turn into a contentious issue in economics.The production possibility curve represents graphically alternative production possibilities open to an economy. Not only may this be impossible due to the complexity of human nature, it also requires potentially moral or philosophical distinctions that are difficult to quantify. Difficult Comparisons: Pareto efficiency requires comparison of different individuals which can be difficult to do in practice.Transaction costs such as the cost of negotiating contracts or the cost of enforcing property rights can affect the efficiency of resource allocation. Transaction Costs: Pareto efficiency assumes that all transactions can be completed at zero cost, which is not always the case.For example, consider externalities and resource allocations that cause pollution. This means that a Pareto-efficient allocations could still result in negative externalities. Externalities: Pareto efficiency only considers the benefits and costs that accrue to the parties directly involved in a transaction, without taking into account any external effects on third parties.Some beings simply have more power than others. In reality, however, markets are often imperfectly competitive. Perfect Competition: Pareto efficiency assumes that markets are perfectly competitive, meaning that all buyers and sellers have equal market power and perfect information.Because this concept requires human intervention and analysis, the Pareto efficiency curve on its own does not consider moral distributions or equality across resource recipients. Distribution Analysis: Pareto efficiency curves can be used to analyze equity, but they themselves do not automatically consider implications of fairness.
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