The Search For A Free Lunch

This chapter has argued that every decision to produce more of something requires us to pay an opportunity cost by producing less of something else. Nobel Prize-winning economist Milton Friedman summarized this idea in his famous remark, "There is no such thing as a free lunch." Friedman was saying that, even if a meal is provided free of charge to someone, society still uses up resources to provide it. Therefore, a "free lunch" is not really free: Society pays an opportunity cost by not producing other things with those resources. The same logic applies to other supposedly "free" goods and services. From society's point of view, there is no such thing as a free airline flight, a free computer, or free medical care. Providing any of these things requires us to sacrifice other things, as illustrated by a movement along society's PPF.

But what if an economy is not living up to its productive potential, but is instead operating inside its PPF? For example, in Figure 1, suppose we are currently operating at point W, where the health care system is saving 200,000 lives and we are producing 400,000 units of other goods. Then we can move from point W to point E and save 200,000 more lives with no sacrifice of other goods. Or, starting at point W, we could move to point C (more of other goods with no sacrifice in lives saved) or to a point like D (more of both health care and other goods).

As you can see, if we are operating inside the PPF, Friedman's dictum does not apply—there can be such a thing as a free lunch! But why would an economy ever be operating inside its PPF? There are two possibilities.

Productive Inefficiency. One reason an economy might be operating inside its PPF is that resources are being wasted. Suppose, for example, that many people who could be outstanding health care workers are instead producing other goods, and many who would be great at producing other things are instead stuck in the health care industry. Then switching people from one job to the other could enable us to have more of both health care and other goods. That is, because of the mismatch of workers and jobs, we would be inside the PPF at a point like W.Creating better job matches would then move us to a point on the PPF (such as point E).

Economists use the phrase productive inefficiency to describe the type of waste that puts us inside our PPF.

Productive inefficiency A situation A firm, industry, or an entire economy is productively inefficient if it could in which m°re of at |east one good produce more of at least one good without pulling resources from the pro-

can be produced without sacrific,ng duction of any other good. the production of any other good.

The phrase productive efficiency means the absence of any productive inefficiency. For example, if the computer industry is producing the maximum possible number of computers with the resources it is currently using, we would describe the computer industry as productively efficient. In that case, there would be no way to produce any more computers without pulling resources from the production of some other good. In order for an entire economy to be productively efficient, there must be no way to produce more of any good without pulling resources from the production of some other good.

Although no firm, industry, or economy is ever 100 percent productively efficient, cases of gross inefficiency are not as common as you might think. When you study microeconomics, you'll learn that business firms have strong incentives to identify and eliminate productive inefficiency, since any waste of resources increases their costs and decreases their profit. When one firm discovers a way to eliminate waste, others quickly follow.

For example, empty seats on an airline flight represent productive inefficiency. Since the plane is making the trip anyway, filling the empty seat would enable the airline to serve more people with the flight (produce more transportation services) without using any additional resources (other than the trivial resources of the airline meal). Therefore, more people could fly without sacrificing any other good or service. When American Airlines developed a computer model in the late 1980s to fill its empty seats by altering schedules and fares, the other airlines followed its example very rapidly. And when—in the late 1990s—a new firm called Priceline.com enabled airlines to auction off empty seats on the Internet, several airlines jumped at the chance, and others quickly followed. As a result of this—and similar efforts to eliminate waste in personnel, aircraft, and office space—many cases of productive inefficiency in the airline industry were eliminated.

The same sorts of efforts have eliminated some easy-to-identify cases of productive inefficiency in all types of industries: banking, telephone service, Internet service providers, book publishers, and so on. There are certainly instances of inefficiency that remain (an example appears at the end of this chapter). But on the whole, if you search the economy for a free lunch due to productive inefficiency, you won't find as many hearty meals as you might think.

Recessions. Another situation in which an economy operates inside its PPF is a recession—a slowdown in overall economic activity. During recessions, many resources are idle. For one thing, there is widespread unemployment—people want to work but are unable to find jobs. In addition, factories shut down, so we are not using all of our available capital or land either. An end to the recession would move the economy from a point inside its PPF to a point on its PPF—using idle resources to produce more goods and services without sacrificing anything.

This simple observation can help us understand, in part, why the United States and the Soviet Union had such different economic experiences during World War II. In the Soviet Union, the average standard of living deteriorated considerably as the war began, but when the United States entered the war, living standards improved slightly. Why?

Figure 2 helps to solve this puzzle. The PPF in Figure 2 is like the PPF in Figure 1. But this time, instead of pitting "health care" against "all other goods," we look at society's choice between military goods and civilian goods. When the United States

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