Question

Assume an economy which has no government intervention and with only two individuals, Mark and Tom, who produce fish and sugarcane using the resources they have namely labour and capital (assume natural resources to be given). With the aid of well labelled diagrams, use the benchmark model to show a situation where production activities are Pareto optimal in the above mentioned economy.

Answer 1

Consider that the production possibilities frontier (PPF) for Mark is represented by line AB in the diagram below. As observed, if Mark uses all his respurces to produce sugarcane, he can produce OA and if he uses all his resource to produce fish, he can produce OB. All the points on his PPF efficiently use his resources, below the frontier, the resources are underutilised and above it, the combinations are infeasible with the level of his resources.

Similarly, line A'B' represent Tom's PPF.

Consider a point P on the diagram, which is infeasible for both Mark and Tom if they produce and consume their own sugarcane and fish respectively. However, if they cooperate and specialize as per their comparative advantage (opportunity cost), they can do better. We can demonstrate this by the combined PPF. The curve A''TEB'' represents the combined PPPF of Mark and Top which has been derived by additing both of their PPFs. Now, all the points on the curve A''TEB'' are pareto effeicient. All points below this curve such as P, Q, R are pareto inefficient and points above the curve such as S are stilll infeasible.