Ch.

2: Economic Activities:
Producing and Trading

INSTRUCTOR: KANTI ANANTA NUZHAT

SUMMER 2019
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 and fully employed
resources.
Straight Line PPF: Constant
Opportunity Costs

 Assumptions:

1. Only two goods can be produced in an economy:

computers and television sets.

2. OC of one computer is one television set.

3. As more of one good is produced, OC between the

two goods is constant .

➢ Therefore PPF is a straight line

Straight Line PPF: Constant
Opportunity Costs
Bowed Outward PPF:
Increasing Opportunity Costs

 Assumptions:
1. Only two goods can be produced: computers and
television sets
2. As more of one good is produced, the OC between
computers and television sets changes.

➢ As the economy produces more television sets, the

OC of producing television sets increases; and gives
a bowed outward PPF.
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

1. Scarcity of resources:
▪ Attainable (points on the PPF and inside) and
unattainable regions (outside the PPF).
▪ Choice and opportunity cost arise.
2. Productive Efficiency:
▪ 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.
3. Unemployed Resources.
Q&A
 What does a straight-line production
possibilities frontier (PPF) represent? What
does a bowed-outward 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.
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.
Economic Growth

 Increased productive capabilities of an economy.

 Illustrated by an outward shift in PPF.

 Two factors affect economic growth:

1. increase in quantity of resources,
2.an advance in technology.
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.
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.
Cost of Trades:
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 (example: a real estate
broker lowers the transaction cost of buying
and selling a house; online shopping).
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.
 For example: cigarette
smoking can cause
negative externalities.
Q&A

 What are Transaction Costs?

 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, and trading it for another can increase
gains for both parties!
Comparative Advantage

Elizabeth Brian
Bread Apples Bread Apples
20 0 10 0
10 10 5 15
0 20 0 30
Gains of specialization from
trade
No Specialization Gains from
specialization and trade specialization
and no trade and trade

Elizabeth Consumption 10 12 +2
of loaves of
Bread

Consumption 10 12 +2
of Apples

Brian Consumption 5 8 +3
of loaves of
Bread

Consumption 15 18 +3
of Apples
 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.