But There ARE Free Lunches!
Creative discovery is the source.
MAY 31, 2011 by SANDY IKEDA
Filed Under : Scarcity, Entrepreneurship, Opportunity Cost
There’s an old saying: “There ain’t no such thing as a free lunch,” or TANSTAAFL for short (or TINSTAAFL for the more grammatically correct). For many this contains the gist of sound economic teaching: If you don’t pay for your own lunch, someone else will have to.
I’ve always taken this simple and valuable statement for granted and hadn’t thought about it very much. Lately though I’ve been puzzling over it because I’ve come to realize that there are free lunches – it is possible to create something from nothing. In fact, I think for economic growth to take place there have to be free lunches, lots of them. Let me explain.
The Truth Behind TANSTAAFL
In a world of scarcity you can’t have everything you want. For one thing, time is scarce. I can spend the next hour sleeping in bed or working out at the gym, but if I do one I can’t do the other. Same thing with any other scarce resource. My labor is scarce — I can’t be in two places at once, for example — so I have to decide whether to take a full-time job in New York or one in London. My money is certainly scarce, so I can either spend a given $20 on a good lunch or a good book.
So scarcity makes it necessary to choose between two or more valuable alternatives. The more scarce something is, the more valuable it becomes and, other things equal, the more likely I will choose it over the next best alternative. The value of that next-best alternative, what I don’t choose, becomes the (opportunity) cost of the thing that I do choose. If I choose to sleep, then the cost is the value I attached to going to the gym. If I decide to work in London, the cost is what I think the value of working in New York would have been. And if I decide to spend $20 on a book, the cost is the expected value of a good lunch.
How to Make a Free Lunch
Suppose I’m in the business of making lunches. Let’s say that with my current know-how I can make a maximum of 20 lunches a day by using two units of labor and four units of capital. One day I discover a way to make two lunches of the exact same kind, at least from the perspective of my customers, with the same amount of inputs that it previously took to make one. In other words, before that fateful day I was selling lunches inefficiently; I was producing only half the lunches that I could have been. Discovering that inefficiency means I can create 20 additional lunches.
Alternatively, I could produce 20 lunches a day as before and use the one unit of labor and two units of capital that my increased efficiency saves to produce some other valuable good, say, ten dinners or 30 breakfasts or some other thing that no one had ever thought of making before. Those would all be “free lunches” in the same sense.
Now, it’s true that all those extra things that I could now make still use labor and capital, so they’re not costless to produce, and in that sense TANSTAAFL is true. But it’s also true that creative discovery, what Israel Kirzner calls “entrepreneurship,” creates value where none existed before.
The Production Possibilities Frontier
It might help to clarify things to introduce the concept of “production possibilities frontier,” or PPF. The PPF tells us the maximum amount of all kinds of goods, say, lunches and books, that can be produced with the best-available technology from a given set of labor and capital. So with two units of labor and four units of capital, let’s say you can produce either 40 lunches and no books or no lunches and ten books, or any combinations of the two – for example, 36 lunches and one book, 32 lunches and two books, and so on. Think of the PPF as a downward-sloping curve with lunches measured on the horizontal axis and books on the vertical axis. So, as I indicated, producing more books means making fewer lunches as we travel up that curve.
We’ve already seen through my first example — where at first I don’t know I can make more than 20 lunches a day — that I would not be on the curve itself but rather somewhere inside the frontier – that is, I’m not producing efficiently. Producing more (free) lunches or more (free) books means moving onto the curve. That’s one way that entrepreneurship can create free lunches. And there are at least two more kinds of free lunches that entrepreneurship can create in this way.
Even More Free Lunches
Entrepreneurship can to shift the PPF outward. Even if you’re presently on the frontier and are producing efficiently, discovering a new source of labor and capital or inventing a new way of making lunches or books means that you can stretch that curve out farther, producing more lunches or more books or more of both than was possible before, without using any more inputs.
The third way is for entrepreneurship to add a completely new dimension to the curve by introducing a new kind of good or service. Edison’s incandescent light bulb, Ford’s Model T, and Jobs’s iPad are examples. So if you were on the frontier of the curve before, you may find yourself off of it again once its dimensions expand.
There are ways to create free lunches — a net increase in value without any increase in cost — that don’t involve production at all. Suppose I’m eating a nice sandwich but about halfway through I realize that I don’t really want to finish it, that it would actually be best if I stopped eating it and throw the rest away. The free lunch here isn’t the sandwich I didn’t eat, but the realization that I didn’t have to finish it. That may sound strange, even wasteful, but in the economic sense it’s not. Any discovery that makes me better off, whether it’s producing and consuming more or producing and consuming less is a free lunch. Economists call this “consumption efficiency.”
In other words, discovering a production inefficiency is a free lunch. Discovering a consumption inefficiency is also a free lunch.
So even if Thomas Edison was right that “genius is 1 percent inspiration, 99 percent perspiration,” that 1% is free.