Why do economists assume tradeoffs?

It's Principle #1 of Greg Mankiw's Intro text's Ten Principles of Economics: "People Face Tradeoffs". Why? Why do economists always make this assumption? Why does having more of one good thing always have to mean having less of another good thing? Is this some fact of nature? Is Nature such a meanie that she can't ever let us have more of something we want without feeling she has to take away from us something else that we want? Why do economists have such a pessimistic, not to say anthropomorphic, view of nature?

And what about the examples that seem to contradict this Principle of Economics? Fuel injection gives more power than carburetors, and better fuel economy!

I made the same assumption of tradeoffs in my last post. I just assumed, without any argument whatsoever, that it cost more to build stuff that lasts longer. So there's a tradeoff between cheap to build (which we want) and longevity (which we want). Why? Maybe, when big trees are cheap and saws are expensive, it's actually cheaper to build a barn using big beams, rather than sawing them up. So a cheaper barn will also last longer.

Take a large bit of graph paper, with axes Y and X. Pin it to a wall. Stand back 30 paces and fire a shotgun at it. Suppose both Y and X are goods -- things we want more of. Or suppose they are both bads we want less of; or that Y is good and X is bad; or vice versa; it doesn't matter. It doesn't matter for Nature either. She doesn't know what we want, or care. Each hole in the graph paper is something that Nature lets us do, if we chose it. Or something we know that Nature lets us do. Each hole in the paper represents a particular technique, a particular way of building a barn, or a car. The sum total of all the holes represents the state of our technical knowledge, our technology, at a given time.

There is no tradeoff between X and Y. R-squared is zero, or close to it. (And if R-squared is negative in one case, it is as likely to be positive in another case.) What Nature lets us do, and what we want to do, are uncorrelated.

There is no tradeoff in nature. But there is a tradeoff in the bits of nature that interest us. If both Y and X are goods, we have no interest in any part of the shotgun pattern except those holes along the North-East boundary.

Call one hole A. If there is another hole B, that has more Y and more X than A, we can ignore A. Nobody would build a barn using technique A if there is another technique B that is both cheaper and creates a longer-lived barn than A. (This is a 2-dimensional model where there are only 2 things we care about; if you care about 3 things, then add a third dimension, and so on.) We are only interested in techniques that are not dominated by any other technique. (That's weak-dominance for the picky, because if B has the same Y but more X than A, then we have no interest in A).

Look at the North-Eastern boundary of the shotgun pattern -- all the techniques that are not dominated by some other technique. Almost certainly, that boundary will show a tradeoff between X and Y. (And it will probably be convex as well, though that's another story, about diminishing returns and increasing marginal costs). If we start with one technique on the boundary, and we want to switch to a second technique that has more Y, it must have less X. And vice versa.

Only in weird cases will there be no tradeoff at all. That's when one pellet flies so far out of the pattern that it is both further North of every other pellet and further East of every other pellet. That technique dominates all others. We choose only that technique, regardless of how much value we place on Y relative to X. Any other way of building a barn would cost more and result in a shorter-lived barn. The North-Eastern boundary is a single point, not a negatively-sloped set of points. But that's a weird case.

That's why economists assume tradeoffs.

Comments

[Brett]

So taking the analogy back to yesterday's post, perhaps technology gives us more pellets. In the past, in certain situations, you had a way to build a bridge that would last a long time or a way to do it that was inadequate, so if you wanted it done, you had no choice. Now we have a finer gradient.

[Nick Rowe]

Brett: exactly! When we discover new techniques, we add more pellet holes to the pattern, and technology improves. But only those new pellet holes which extend the North-Eastern boundary outwards are of any interest to us. (And in a Dark Age, where we forget techniques, pellet holes disappear, and the NE boundary may shift inwards.

And when the NE boundary shifts outwards, with new technology, it may get flatter, or steeper. Maybe, for example, new stuff is short-lived because we have discovered new ways to build cheaper shorter-lived barn, but haven't discovered new ways to build expensive long-lived barns in a slightly less expensive or longer-lived way. So the slope of the tradeoff has changed, to favour short-lived.

[Frances Woolley]

Nick, assuming there's always trade-offs is equivalent to assuming that we're always at a Pareto efficient point. It's not possible to make one person better off without making another person worse off.

Why might we not be at an efficient point? Because people are stupid and can't work out how to do things efficiently (I'm remembering the car my dad had once with a stick shift *and* a bench-type front seat which was so hard for people with short legs to drive).

Or because there's some kind of cost associated with getting to the efficient point, some kind of coordination that's difficult, or investment in new technology or...

This later is perhaps a Coasian/Chicago type view that wherever we are must be efficient because if there was something else that was better for everyone else we would be there not here.

[Alex Tabarrok]

Shorter version: We assume tradeoffs because they are implied by maximization.

[Andrew F]

The set or continuum of weakly dominant points is called the efficient frontier (at least in portfolio optimization). I think the reason why economists assume trade-offs is because it is a corollary of the rational actor assumption. An irrational actor may choose a dominated point, as we see with investors with high-risk, low-return portfolios.

[Nick Rowe]

Frances: Funnily enough, I got the idea for thinking about trade-offs this way from a Sidney Afriat lecture on X-inefficiency at Carleton, decades ago. He drew some random dots on the board! Not wanting to get too deep into it, but I think of the "feasible" set as being feasible in *all* ways, not just possible in principle, but feasible in practice. But then I think of Arthur Laffer's dictum: "Of course there are free lunches; it's our job as economists to find them and eat them".

Alex. Maximisation is necessary, but is it sufficient? Suppose Nature really were weird, and she does know and care about human wants, so she decides to make all feasible sets look like this: / . We go to the North-East point, and there's no trade-off.

[Min]

"There is no tradeoff in nature."

What do you mean? Haven't you heard of conservation laws, conservation of matter, of momentum, of energy? Haven't you heard of the second law of thermodynamics?

[Min]

"What Nature lets us do, and what we want to do, are uncorrelated."

Haven't you heard of evolution?

[Kien Choong]

Hi Nick,

You might also share your thoughts on why economists assume that it is always possible to trade-off. I know this is not strictly true, but the assumption that X and Y are at least partial substitutes is often made, and sometimes controversially made.

I'm thinking in particular about the assumption that natural assets can be traded off with man-made assets. This point did not occur to me as profoundly controversial until I did a course on climate change and realized how important this issue is.

It made me wonder whether there might be other things in life that economists assume can be bought or sold at some price. Again, I have tended to side with the economist on this. But I wonder now how justified this assumption is, and whether this may explain the limits of economics.

If, within society, there is a group of people who, with some justifiable reason, consider certain things to be so fundamental to their lives and values that it cannot be traded off, might economists pause and concede that their policy prescriptions have limited applicability in such situations. A particularly vexed example of this might be aboroginal people who occupy land in common among themselves. Might there be other examples within modern society? Or do we think that with modernity, everything can be traded-off?

Incidentally, my understanding is that economists also typically assume that human life can also be traded-off. Admittedly, it is perhaps an assumption reflecting "reality", not a normative judgement.

I've not thought all of this through. Just some random comments prompted by your post!

Regards,

Kien

[Nick Rowe]

Min: No, I've never heard of any of those things ;-)

Suppose there is a physical law of nature that says that X and Y are negatively correlated. If X and Y are both goods, or both bads, we have Nature creating a tradeoff. But if X is a good and Y a bad, or vice versa, Nature has not created a tradeoff. Both cases seem equally likely to me, a priori. There seems to be no obvious correlation between human preferences and Nature's "preferences". Sometimes they line up; sometimes they don't. I did wonder about evolution when I wrote that bit. But I still couldn't think of any reason why that would create tradeoffs.

Kien: Every time I drive into work I place a value on my own life. It's the wages I earn, divided by the risk of getting killed in a car crash. (Well, that puts an upper bound on the value of my life, anyway, if I have other costs of going to work.)

There are two sorts of tradeoffs. One created by our technology and resources, showing all the possibilities open to us. The second is our subjective tradeoffs, showing our preferences between different choices. (In an efficient equilibrium, those two tradeoffs should have the same slopes, locally, so that our subjective willingness to tradeoff one good against another equals the tradeoff allowed by technology and resources. I was talking about the first sort of tradeoff in this post; you are talking mostly about the second.

Maybe there are some goods that people are unwilling to give up at all, in any small amount, for any amount of other goods. And maybe economics doesn't have much to say in such cases. That's OK by me. But sometimes when people say they would be unwilling to put a price on something, they aren't being sincere. The price of life may be such a case.

"I'm thinking in particular about the assumption that natural assets can be traded off with man-made assets. This point did not occur to me as profoundly controversial until I did a course on climate change and realized how important this issue is."

You lost me here. I don't see anything profoundly controversial there. We have been making that tradeoff throughout history. Any living person who denies they make that tradeoff is, I think, being insincere. Or self-delusional. Our very existence affects "natural assets" (insofar as it makes sense to talk about humans as being non-natural, which it doesn't really).

[Min]

Nick Rowe: "If X and Y are both goods, or both bads, we have Nature creating a tradeoff."

By your use of the terms, "good" and "bad", I gather that you are talking about tradeoffs in terms of value. In this scientific age, we do not think of Nature as being concerned with values. :)

[Nick Rowe]

Min: But that's my whole point! Because Nature is not concerned with (our) values, she is as likely to create a positive as a negative relation between two things, X and Y, that we value. Nature just creates a shotgun pattern, relative to our values.

[Luis H Arroyo]

Nick, good point.
I think Trade off is into the Human Nature: election capacity in Time. We are condemned to choice timely. All in life is trade off. Any decision has an alternative; but we don´t know a priori the consequences of either. The advance in technology change our alternatives, but election persist forever. Is not that our only real predestination?

[Just visiting from Macleans]

Real world example: Project Management

This is an a argument/point I have used when explaining why a particular project was managed a certain way.(You can use this explanation at home as well, for example, when your spouse wonders why you haven't finished painting the house, etc)

There are three things to consider: Schedule, quality and cost.

You can have two, but not all three. Which two would you like?

Tight schedule/opportunity cost is high - we can throw a lot of resources at it, pay overtime; or we can take risks/cut corners (overdesign for example)

Tight budget, strict schedule - quality will suffer

Highest quality (say nuke plant) - hire experts - schedule is long for Quality Assurance

[Min]

The original question is "Why do economists assume tradeoffs?" Without natural constraints, there are no human tradeoffs, and natural constraints are everywhere.

[btg]

"And what about the examples that seem to contradict this Principle of Economics? Fuel injection gives more power than carburetors, and better fuel economy!"

but, fuel injection costs more - the tradeoff is higher initial capital cost.
so, unless some technological breakthough suddenly reduces the cost of fuel injection, , or the cost of gasoline increases to make the fuel savings outweigh the costor some other factor, like tougher pollution controls, forces the switch to fuel injection to meet emissions standards, then there is a trade-off.

and this is what happened - tougher emissions standards meant that most cars needed computers to manage the engine, plus fuel injection is far more efficent that a carburetor or throttle body injection - by more precisely delivering just the right amount of fuel to each cylinder, power and fuel economy were enhanced.

[GA]

I think your carburetor/fuel injector question gives some insight. Before invented, the fuel injector was not on the plane of possible choices. After it was invented, it was expensive, unreliable, not much more efficient except in certain applications, etc. It got refined, improved, tested, better built, and eventually got some major economies of scale. Carburetors all but disappeared (economies of scale started to disappear, as did investment in new improved technologies, manufacturing, etc). There was also some trust/learning curve for both users, mechanics, etc.

The point is, the precise set of trade-offs changed quite a lot over time. I remember when few people trusted fuel injectors; it didn't last long.

[Jimmy]

The concept of tradeoffs stems from the first law of thermal dynamic, energy can be neither created nor destroyed. It can only change forms. This means that, ultimately we are dealing with a closed system (plant earth). Since we have only a finite amount of energy and matter, every action we take will always have a trade off.

[Alex]

there's a tradeoff between cheap to build (which we want) and longevity (which we want)

I don't think the analogy with the axes and the shotgun really explains why there's a tradeoff in this situation, or possibly in many other economic situations.

Surely concepts like cheapness and longevity of a material will be some function of atomic structure, and solar system formation. Nature is not random.

Moreover, its impossible to separate this from its social context. Answering the question "Is there a tradeoff?" surely depends on what other people want too, and how their desires affect prices and thus the tradeoff itself (i.e. the tradeoff decision can be self-reinforcing [or perhaps the opposite]).

[Nick Rowe]

Alex: Nature is not random. Our preferences are not random. But there's no obvious relation between Nature and our preferences. Even if the *relation* between Nature and our preferences is random (which is what I assumed) we still get tradeoffs.