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 UtilityIncreasing 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 ones 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

1)
2)
3)

To the Capitalist Thinker:

Prices Ration Goods and Services
Prices convey Information
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 peoples 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

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 peoples 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.