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We've already spent a lot of time
thinking about these six different scenarios,
all of which sit on the production possibilities frontier,
which means that in any of these scenarios
we have achieved productive efficiency.
And it's true not just of these scenarios,
it's true of any of the points on this curve.
So you have achieved,
[for] any point on that curve, productive...
-Let me give ourselves some real-state on the right-
productive efficiency,
which means.....
Another way to think about it, is that
as soon as you're at any point on that curve,
if you want any more of one of these things,
you have to give up some of the other.
So for example, if you're at point C,
and you if want more rabbits,
If you want one more rabbit,
you're going to have to give up some berries.
Or, if you're at point C,
and you want more berries,
you're going to have to give up some rabbits.
That's true of any point on the production possibilities frontier.
A point over here
-let me do this in a different color-
So let's say that [for] this point right over here,
you have not achieved productive efficiency here,
because you can get more rabbits
without having to give up any berries.
And you could get to scenario B.
Or, you could get more berries,
and not have to give up any rabbits.
And you would get to scenario D.
So this right over here is inefficient.
Now, all of these are all good.
[In] all of these six scenarios
we have achieved productive efficiency.
But which of these do we pick?
How do we decide [how] to allocate our time?
So what I want to talk about in this video is
"allocative efficiency".
And it's somewhat subjective,
based on the preferences of ...
if we are the hunter gatherer, based on our preferences.
But at least it gives us a framework for thinking:
which of these meets our preferences the best?
And to do that, I will review a little bit from the last video.
In the last video, we talked about the marginal cost
of each incremental rabbit.
We said the opportunity cost of each incremental rabbit
and the opportunity cost of one incremental unit
that really is just the marginal cost.
So let's just write these different scenarios.
So these are the [scenarios],
Let's write the scenarios, scene for short.
And then let's think about the marginal cost
of one incremental rabbit,
-I just draw a rabbit here-
of one incremental rabbit.
And it's going to be given in berries
All right, let's start with scenario F
and this is all review from the last video.
Sitting in scenario F,
if we want to get one extra rabbit
we are going to have to give up 20 berries.
In senario E, if we are sitting in scenario E
and we want even one more rabbit,
we now have to give up 40 berries.
So the marginal cost of that point of one more rabbit
is forty berries.
Now let's go to scenario D
and I encourage you to pause and do this yourself.
It'll help if you kind of work it out.
Scenario D
the cost of one extra rabbit is now 60 berries.
You go to scenario C.
The cost is now 80 berries.
Finally we go to scenario B.
And the cost of sitting in scenario B of getting one extra rabbit
you are going to give up 100 berries.
And I won't even go into scenario A
because it will be impossible for you to have any more rabbits.
You have no more berries to give up.
So these are all the possible scenarios
and the marginal cost of them
and we can actually plot them on a line.
So let me do that right over here.
This will be useful.
And so, let me draw one axis right over here.
One axis over here,
and let's call these the different scenarios.
So let me do it in the same order.
Let's call this scenario F,
scenario E (I'll just do this in one color right now),
scenario D, scenario C, and scenario B.
Actually, instead of doing it that way,
let me just talk about it in terms of
the number of squirrels I have.
In scenario F, if you remember...
oh, not squirrels, rabbits.
In scenario F, you have zero rabbits.
zero, one, two, three, four, and five.
So this is the number of rabbits,
not squirrels,
the number of rabbits
that you are able to catch on average each day.
And in the vertical axis,
right now, I want to put the marginal cost,
the marginal cost in berries.
Let's see, it goes from 20 up to 100.
So let's say that this is
twenty, forty, sixty, eighty, and one hundred.
So scenario F - that's when we had zero rabbits -
and the marginal cost of trying to get another rabbit,
you would have to give up twenty berries.
So that is scenario F right over there.
Scenario E - that's the one
where we already had one rabbit
and we are thinking about the marginal cost
of getting another one. So that's scenario E.
It's right over there.
This is scenario D - the marginal cost is 60 -
We already have 2 rabbits and
are thinking about getting a third.
That's scenario D.
And then scenario C -
we already have three rabbits
and [we are] thinking about getting a fourth -
That's scenario C.
And then finally, we have scenario B,
where we already have four rabbits,
and we are thinking about getting a fifth
and we would have to give up
100 berries to get that fifth rabbit.
So that's scenario B right over there.
So what I have just done is plotted the marginal cost
along, these are points on our "marginal cost curve",
our marginal cost as a function
of the number of rabbits [that] we have.
So let me connect all the dots.
And in this scenario, it just happened to be a line.
It doesn't always have to be a line,
but in many introductory economics courses,
it's often a line for simplicity.
So let me make this a line right over here.
This is our marginal cost as a function
of the number of rabbits [that] we have.
And actually, I should probably draw this axis.
Let me copy and paste this.
So let me cut that.
And then let me paste it,
because it really should sit
on the zero point right over there.
And ignore that little line right over there.
So there you have marginal cost as a function of berries.
But we still don't know which scenario to pick,
and to think about that,
I want to introduce something called
the "marginal benefit",
and I'll write it as MB.
The marginal benefit of an incremental rabbit,
and once again we're going to write it in berries.
The way to think about the margin benefit,
is if we are the hunter-gatherer,
we're saying,
if we're sitting in one of these scenarios,
how much would we pay to
some hypothetical convenience store in berries.
Maybe that convenience store only sells bunnies
and they only accept berries.
How much would we pay to them in berries
for an extra rabbit?
And let's not even look at this thing right over here.
So we're sitting in scenario F -
and you remember scenario F is right over here -
We have no rabbits -
how much would we be willing to pay?
We have no rabbits, and we actually have a ton of berries.
So in scenario F, we have no rabbits,
and we have 300 berries.
If we have no rabbits and a lot of berries,
so let's say - we have a lot of berries,
we might be in the mood for a rabbit -
We'd be willing to pay a lot in berries for a rabbit.
So let's say we would pay 100 berries
to that hypothetical convenience store for a rabbit.
Now, let's say that we're in scenario E,
how much would we pay to that
hypothetical convenience store?
Well in scenario E, we already have one rabbit
and we have fewer berries,
so we need a rabbit less,
and we have fewer berries to give.
So we're not willing to give
quite as many berries for another rabbit.
So maybe we'll only give 80 berries.
Then you go to scenario D,
we already have two rabbits,
and we have even fewer berries.
So we're willing to give even fewer berries for another rabbit.
This is what we would pay to a convenience store,
based on our current preferences.
Then we can go all the way to scenario C -
and it is subjective. It's not like a measurable thing.
It's based on this person's preferences,
this hunter-gatherer's preferences.
Scenario C - well, even more -
they already have more rabbits, even fewer berries.
So they will pay even less.
Then finally scenario B they have a good number of rabbits
and even fewer berries.
They'd be willing to pay very little for an incremental rabbit.
So let's plot the marginal benefit
as a function of the number of rabbits that they already have.
So if we go to scenario F, the marginal benefit,
doing that little thought experiment, is 100.
In scenario E, the marginal benefit -
how much you would hypothetically be willing to pay in berries?
It's now 80 berries.
In scenario D, it is 60 berries.
In scenario C, it is 40 berries.
So scenario C is right over here, and scenario C is 40 berries.
In scenario B it is 20 berries, just like that.
Now we are not just plotting the marginal cost,
we are plotting the marginal cost
and the marginal benefit in berries.
The marginal benefit curve is really a line here,
once again for simplicity, looks like that.
Now given this, this is the marginal benefit curve.
Marginal benefit is a function of the number of rabbits
that we already have.
And, this is the marginal cost
as a function of the number of rabbits we already have.
So when I say E, this is the situation E.
That's situation D.
This is also situation C.
This is the marginal benefit at situation B.
Given this, what would I rationally do?
These are really my preferences.
What would I rationally do?
If I am sitting here in situation F.
I have no rabbits.
I already know that it'd cost me 20 rabbits
to try to get an incremental one.
But I've already said I am willing to pay 100.
Sorry it costs me 20 berries to get an incremental rabbit.
But I already said I am willing to pay 100 berries
to get an incremental rabbit.
So I would want to move along the curve.
So I would definitely want to get more rabbits.
I said I am willing to pay 100 berries for a rabbit.
It would only cost me 20 berries for a rabbit.
So I definitely...I am saying I want to get more rabbits.
And another way to look at this visually,
marginal benefit is much higher than marginal cost here.
So I am will to go forth and try to get more rabbits.
That's even true in scenario E.
The marginal benefit of an incremental rabbit
is worth much more to me than marginal cost.
So I am willing to get more rabbits.
So scenario E, I am still trying to get more rabbits.
I still want to move along the production possibilities frontier
in this general direction.
Now what happens when I am in...
What happens as I get closer to D?
So if I am in this scenario right over here
This isn't one of my label scenarios.
But if I am right over there,
still my marginal cost is lower than my marginal benefit.
I will still want to get more rabbits,
all the way to scenario D.
In scenario D I am a little bit neutral.
I am willing to pay 60 berries for a rabbit.
But that's exactly how much I'd have to give up
to get that extra rabbit.
Let's just think about scenario D for a little bit.
I just circle it right over here.
It looks kind of interesting.
Now let's go ... now we want to do anything beyond scenario D.
So if I am at this point right over here,
if I am working enough on average to get 2.5 rabbits a day,
would I...
does this make sense for me to try to get any more rabbits?
At that point, the benefit to get an incremental rabbit
is smaller than the cost of getting a rabbit.
At that point, if I try to get another rabbit,
I am getting less benefit from it than the cost associated with it.
So I definitely don't want move past D.
I achieve allocative efficiency
where my marginal cost and my marginal benefit is equal.
So based on the way that I've rigged the numbers
in this example right over here,
you want to settle on scenario D.
We have achieved allocative efficiency over there.
The marginal cost as a function of our rabbits and
the marginal benefit of our function of rabbits is equal.