Chapter 2 Economic Activities: Producing and Trading

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Chapter 2 Economic Activities Producing and
Trading
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Costs of Trade

• Transaction costs
• Time and effort needed to search out, negotiate,
  and consummate a trade
• May cause trades to not take place
• Dont know about the good
• Shipping costs are too high
• Dont like to work with salesperson
• Third-party effects
• Impacts of trade on parties not immediately
  involved
• Second hand smoke (negative externality)

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Producing and trading

• Two people Elizabeth and Brian
• Each produce two goods Bread and Apples
• Elizabeth ? 10 loaves of bread and 10 apples
• Brian ? 5 loaves of bread and 15 apples

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Comparative Advantage

• Should both produce apples and bread or should
  they specialize?
• What does specialize mean?
• Produce the good that you do best
• Produce at a lower costs than other person(s) can
• Called comparative advantage
• Looks at opportunity cost
• What was that?
• What you have to give up
• Give up less?? Have the comparative advantage

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What are the opportunity costs?

• Elizabeth
• If give up 10 apples how much more bread can she
  produce?
• 10 units
• If give up 10 loaves of bread how many more
  apples can she produce?
• 10 units
• Opportunity Costs
• 10 Bread 10 Apples
• 1 Bread 1 Apple

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What are the opportunity costs?

• Brian
• If give up 15 apples how much more bread can he
  produce?
• 5 units
• If give up 5 loaves of bread how many more apples
  can he produce?
• 15 units
• Opportunity Costs
• 5 Bread 15 Apples
• 1 Bread 3 Apples
• 1/3 Bread 1 Apple

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Should we specialize?

• Elizabeth
• 1 Bread 1 Apple
• Brian
• 1 Bread 3 Apples
• 1/3 Bread 1 Apple
• Who produces apples cheaper?
• What does cheaper mean?
• Lower opportunity cost (give up less)
• Brian!!! Give up only 1/3 loaves of bread
• Who produces bread cheaper?
• Elizabeth!!! Give up only 1 apple

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Here is the deal

• Elizabeth produces only bread (20 loaves)
• Brian produces only apples (30 apples)
• Trade 8 loaves of bread for 12 apples
• Breakdown of end result
• Elizabeth Bread?
• 12 loaves (20 - 8 traded)
• Elizabeth Apples?
• 12 apples (0 12 traded)

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• Brian Bread
• 8 loaves (0 8 traded)
• Brian Apples
• 18 apples (30 -12 traded)
• Are they better off??

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Are they better off??
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Are they better off??
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Are they better off??
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Are they better off??
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Both are Better off!!

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Can you do it??
1. Draw the production possibility curves for
both countries. (Clothing on y-axis) 2. Which
country has the comparative advantage in
clothing? Food? 3. The United States and United
Kingdom are negotiating a trade of food and
clothing between the countries. If the terms of
trade is 25 units of clothing for 15 units of
food, should both counties agree?
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Economic System

• The way in which a society decides to answer key
  economic questions
• 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?

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Two major economic systems

• Capitalism
• An economic system based on private ownership of
  capital
• Market economy
• Socialism
• An economic system based on state ownership of
  capital
• Most use pieces of each ? mixed capitalism

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How do they differ

• PPF
• Capitalist Buying behavior of consumers signal
  for producers to produce more/less
• Socialist Government sets up how much to
  produce
• What good to produce?
• Capitalist Consumers and producers decide
• Socialist Government decides

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• How goods will be produced?
• Capitalist producers decide
• Socialist government decides
• For whom to produce?
• Capitalist Consumers decide if they are able
  and willing to purchase the good
• Socialist Government may redistribute funds to
  get certain people certain items
• Trade
• Capitalist view Trade benefits both sides
• Socialist view Trade benefits one side at the
  expense of the other

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• Prices
• Capitalism views
• Rations goods and services
• Conveys information
• Serves as an incentive to respond to information
• Socialism views
• Price is set by greedy businesses with much
  economic power
• Price controls (cant charge more or less than a
  certain price)

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Now we want to use these questions for the next
chapter as we look at

• What a market is and how is it established.

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Homework 3

• Chapter 2
• Questions 1, 5, 12, and 17
• Working with Graphs and Numbers 1, 2, and 5

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In-class exercise 3

• Do we understand Chapter 2?