Trade, Tradeoffs, and Economic Systems

Chapter 2
 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.
 Exchange and Terms of Exchange
• Exchange is the process where things (money,
goods, services, and so on) are traded or
exchanged.
• Terms of Exchange refer to how much of one
thing is traded for how much of something
else.
• Buyers prefer lower prices, sellers prefer
higher prices.
 Unexploited Exchanges
• 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.
 Exchanges 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.
 Trading Without Money

• Remember, Trading is a Utility-Increasing

Activity!
• Barter is exchanging one good for another:
for example, trading apples for bread.
• Economists have shown that making one
product, the trading it for another utility
can increase gains for both parties!
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.
 Three Economic Questions
• What goods will be produced?
• How will the goods be produced?
• For whom will the goods be produced?
 Economic Systems
• The way in which society decides what goods
to produce, how to produce them, and for
whom they will be produced.
• Capitalist, Socialist, & Mixed Economies.
 The Vision of The Economy
• A Vision is one’s sense of how the world
works.
• We refer to the two major viewpoints as
Socialist Thinkers and Capitalist Thinkers.
• Each type of thinker has a different vision for
what drives or should drive the economy.
 Prices
• To the Capitalist Thinker:
1) Prices Ration Goods and Services
2) Prices convey Information
3) Serves as an incentive to respond to
information
• To the Socialist Thinker: Prices are a method
to control business income at the expense of
the society
 Free Markets
• A Capitalist thinker views a free market as
always exhibiting intense competition. This
competition brings about a price which is
equal to what a product is worth.
• A Socialist thinker views a free market as
largely being controlled by corporate interests
that dictate to people what they will buy and
at what price.
 Private Property
• Capitalist thinkers place high value on private
property. Property encourages individuals to use
their resources in ways that benefits others so the
property-owner prospers as well.
• Socialist thinkers believe those who own property
have more political power than those without
property. The Government is more likely to act in a
way that benefits many people instead of just a few.
 Exchanges
• The Capitalist thinker sees the exchange as
mutually beneficial to the buyer and the seller.
• The Socialist thinker sees the exchange as a
method of making one person better off, at
the expense of another.
 Government
• The Capitalist thinker believes government decision makers
respond to well-organized interest groups and not to the will
of the public. Government officials are interested in getting
elected and re-elected to office. When Government members
make a mistake, it is just as likely to be politically motivated as
based off of limited information.
• The Socialist thinker believes government decision makers
promote the best interests of society as a whole. The goal of
government decision makers is to do the right thing, and if a
mistake occurs, it is due to not having the correct information.
 Two Visions in a Nutshell
The Capitalist vision holds that the free market is a
marvelous “system” for rationing goods,
conveying information, producing high-quality
goods at the lowest prices, getting people to use
their wealth to benefit others, and generally
raising people’s standard of living. The
Government is made up of people who will
respond more readily to well-organized special-
interest groups than to the general public.
Capitalist thinkers are less inclined to trust the
intentions and actions of government decision
makers than capitalist thinkers are.
 Two Visions in a Nutshell
The Socialist vision holds that the free market leads to
some people exploiting others (EX: paying high
prices, low wages, and manipulating people’s
desires). The free market is a “system” that enables
some people to better themselves at the expense of
others. The government is made up of people who
want to and will in most cases do the right thing by
the general public. Socialist thinkers are more
inclined to trust the intentions and actions of
government decision makers than capitalist thinkers
are.