Download Decisions & Effects

Ch. 2: Trade, Tradeoffs, and
Economic Systems
Del Mar College
John Daly
©2003 South-Western Publishing, A Division of Thomson Learning
The Production Possibilities
Frontier (PPF)
• The PPF is a graph representing the possible
combinations of two goods than an
economy can produce in a certain period of
time under the conditions of a given state of
technology, no unemployed resources and
efficient production.
Straight Line PPF: Constant
Opportunity Costs
Bowed Outward PPF: Increasing
Opportunity Costs
Law of Increasing Opportunity
Costs
• In the Real World, most PPF lines are
bowed outward.
• For most goods, the opportunity costs
increase as more of the good is produced.
Economic Concepts in a PPF
Framework
• The economy is efficient if it is producing
the maximum output with given resources
and technology.
• The economy is inefficient if it is not
producing the maximum output with the
given resources and technology.
• Efficiency implies gains are impossible in
one area without losses in another area.
Technology
• Technology refers to the body of skills and
knowledge concerning the use of resources
in production.
• An advance in technology commonly refers
to the ability to produce more output with a
fixed quantity of resources or the ability to
produce the same output with a smaller
quantity of resources.
Q&A
• What does a straight-line production possibilities
frontier (PPF) represent? What does a bowedoutward PPF represent?
• Would you expect to see more or fewer political
battles in a stagnant economy? What about a
growing economy?
• A politician says, “If you elect me, we can get
more of everything we want.” Under what
conditions is the politician telling the truth?
• In an economy, is there only one combination of
goods that is efficient? Explain your answer.
Exchange or Trade
• Why do people trade?
• To make themselves better off.
Time Relevant to Exchange
• Ex Ante: Before the Trade or Exchange has
occurred.
• At the Point of Exchange or Trade.
• Ex Post: After the trade has occurred.
Consumers’ and Producers’
Surplus
• Consumers’ Surplus: The difference
between the price you paid and the
Maximum Price you were willing to pay.
• Producers’ Surplus: The difference
between the price received and the
Minimum selling price.
Trade and Terms of Trade
• Trade is the process where things (money,
goods, services, and so on) are traded or
exchanged.
• Terms of Trade refer to how much of one
thing is traded for how much of something
else.
• Buyers prefer lower prices, sellers prefer
higher prices.
Unexploited Trades
• Transaction Costs are the costs associated with
searching out, negotiating, and completing an
exchange.
• Transaction Costs sometimes keep potential
exchanges from turning into actual exchanges.
• One role of the Entrepreneur is to turn potential
exchanges into actual exchanges by lowering
transaction costs.
Trades and Third Parties
• Third Party Effects:
someone other than the
parties involved in the
exchange was effected.
• If the Third Party
Effects had a negative
effect on the third party,
this exchange effects
negative externalities.
Q&A
• What are Transaction Costs? What is the
producers’ surplus? The consumers’
surplus?
• Give an Example of an exchange
WITHOUT third party effects. Now, give
an Example With third party effects. What
is the difference in the outcomes?
Production and Trading
• Remember, Trading is a Utility-Increasing
Activity!
• Barter is exchanging one good for another: for
example, trading apples for bread.
• Comparative Advantage: The situation where
someone can produce a good at lower opportunity
cost than someone else can.
• Economists have shown that making one product,
the trading it for another utility can increase gains
for both parties!
Q&A
• If George can produce either (a) 10X and 20Y
or (b) 5X and 25Y, what is the opportunity
cost to George of producing one more X?
• Harriet can produce either (a) 30X and 70Y or
(b) 40X and 55Y; Bill can produce either (c)
10X and 40Y or (d) 20X and 20Y. Who has a
comparative advantage in the production of
X? In Y? Explain your answers.
Economic Systems
• The way in which society decides what
goods to produce, how to produce them, and
for whom they will be produced.
• What goods will be
produced?
• How will the goods be
produced?
• For whom will the
goods be produced?
• Where on the PPF will
the economy operate?
• What is the nature of
trade?
• What function do
prices serve?
Economic
Questions
Economic Systems and the PPF
• There are hundreds of countries but only
two major economic systems.
• We refer to these two major systems as
Socialism and Capitalism.
• Most Countries have Chosen Elements from
BOTH economic systems.
Mixed
Capitalist
Economies
• An economic system
characterized by largely
private ownership of
factors of production,
market allocation of
resources, and
decentralized decision
making. Most activities
take lace in the private
sector in this system, but
government plays a
substantial and regulatory
role.
• The United States has a
Mixed Capitalist Economy.
Who or What Should Determine
Where the Economy is on the PPF?
•
•
To the Capitalist
Thinker:
The Market Decides!
To the Socialist
Thinker:
The Market Does Not
Decide; The
Government (usually)
Decides.
What Goods Will Be Produced?
• This is really asking “Where on the PPF
will an economy operate?”
• Capitalist System: The Market will dictate
what goods will be produced.
• Socialist System: The Government will
have a large role in determining what will
be produced.
How Will The Goods Be Produced?
• Under Capitalism, this
is decided by private
producers.
• Under Socialism,
governments play a
large part in deciding
what is produced.
For Whom Will The Goods Be
Produced?
• Under Capitalism, goods will be produced
for those persons who are able and willing
to pay the prices for the goods.
• Under Socialism, there is more government
control over who gets what goods.
Trade
• Under Capitalism,
both parties benefit
from the trade.
• Under Socialism,
Trade is viewed as
making one person
better off at the
expense of another
person.
Prices
Under a Capitalist
System:
• Prices ration goods
and services
• Prices Convey
Information
• Prices Serve as an
Incentive to Respond
to Information
Q&A
• What are the three economic questions
every society must answer?
• How is trade viewed in a Capitalist
economic system? In a Socialist system?
• What does an economic system have to do
with where on its PPF the economy
operates?