Exchange and Consumption
In the last reading, we derived Crusoe's
production-possibilities frontier. Now, suppose that
civilization arrives in the form of the Friday Trading Post.
The trading post trades one fish for one coconut (or one
coconut for one fish). Will the existence of the trading
post make life better for Crusoe? It will if it gives him
more consumption possibilities than his
production-possibilities frontier allows him. To see that it
does, consider what will happen if Crusoe collects eight
coconuts and trades them for fish. He will be able to get
eight fish, which is not a possibility that his original
budget constraint allowed him. The picture below shows that
the consumption-possibilities frontier, which exchange gives
him, allows him options that the production-possibilities
frontier does not allow.
Suppose that before trade, Crusoe was at point a
on his production-possibilities frontier above, and that
once trade is possible, he wants to be at point b. In
order to get to b, he must devote all his time to
gathering coconuts. Some of those coconuts he will consume,
but others he gathers only to trade. In order to get to
where he wants to be, Crusoe must do something he does not
want to do. He must work gathering coconuts.
Exchange requires a person to give in order to get. It
constrains people, forcing them to do things that they do
not want to do in order to accomplish their goals. Adam
Smith wrote about constrained behavior in this
"It is not from the benevolence of the butcher,
the brewer, or the baker that we expect our dinners but
from their regard to their own interest. We address
ourselves not to their humanity but to their self love,
and never talk to them of our own necessities but of
The butcher and baker want to profit from their
businesses so that they can obtain material goods for their
own use. In the pursuit of this goal, they provide a product
to the consumer. If one of these merchants refused to
provide a quality product at a reasonable price, consumers
could take their money elsewhere. The existence of other
sellers provides a limit on each merchant. However, they can
at times find ways to "beat the system." They can stop
competing and monopolize, charging consumers more in the
process. Or they can sell defective merchandise to consumers
who think that they are buying quality merchandise.
The system of market exchange is the most studied system
of constrained behavior with which we live. There are,
however, many other such systems around us. Politicians
would be less sensitive to people's desires if they did not
have to endure elections. Mothers and fathers who tell their
children that they will not get dessert if they do not
finish their meal are using this system, as are grade school
teachers who tell their students that they will get no
recess if they are not quiet. Finally, college students deal
with an interesting system of constraint called the "grading
system" in their struggle to earn a college degree.
Let us consider how the grading system works under some
extreme assumptions. Assume that students want to obtain a
college degree but are totally uninterested in learning
anything in the process of obtaining that degree. Assume
also that the faculty has a goal of increasing student
knowledge, and does not care at all whether or not the
student does graduate.
The faculty can achieve its goals with the system of
tests and grades that is familiar to all college students.
This system forces students to learn what the faculty
members desire in order to obtain a degree. Whether students
are fascinated with what they learn or have no interest in
it at all does not matter in this system. In either case,
learning must take place.
Or must it? College students have long known that there
is in fact a way to "beat the system," that is, one can
achieve the goal without performing as the system requires.
Students can cheat. When they cheat, students still achieve
their goals, but they no longer do those things that they do
not want to do. All systems of constrained behavior have
ways of "cheating" on the system, and if cheating is too
easy, the system will not work well.
If one views college education as a struggle to learn,
with grades and degrees as unimportant by-products, cheating
should never happen. The fact that cheating does occur in
colleges suggests that there is a large element of
constrained behavior in college education.
Sometimes, systems of constrained behavior have been
consciously designed, but often they have grown up
spontaneously, as did the market system. Whether spontaneous
or designed, people often try to change how systems work.
When a system of constrained behavior is complex, and those
making the changes do not fully understand the system, the
results of the changes in behavior can seem surprising and
unexpected to those making the changes. For example,
consider the grading system. If the faculty believed
students are motivated only by a love of learning, it might
decide to abolish grades. It would be surprised when the
amount of learning falls.
When one wants to alter a system of constrained behavior,
it is necessary to understand the system. This necessity
provides a major demand for economists. Governments often
want or need to change incentives in markets, and they often
ask economists for predictions about the effects of those
changes. And even when they do not ask, economists give
answers. A great deal of their scholarly work is concerned
with how the system of market exchange works, and what the
effects of various changes will be. You will see many
examples of economists' concern for the effects of such
changes in the various pages at this site. In some of these
examples, you will see how useful economists find the simple
concepts of budget constraint and production-possibilities