Trade, Tradeoffs, and Economic Systems

Del Mar College

John Daly©2002 South-Western Publishing, A Division of Thomson Learning

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!

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?

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 Law of Increasing Opportunity CostsCosts

• In the Real World, most PPF lines are bowed outward.

• For most goods, the opportunity costs the opportunity costs increase as more of the good is producedincrease as more of the good is produced.

Economic Concepts in a PPF Framework

• The economy is efficientefficient if it is producing the maximum output with given resources and technology.

• The economy is inefficientinefficient 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 & AQ & A

• Would you expect to see more or fewer political battles in a stagnant economy? What about a growing economy?

• In an economy, is there only one combination of goods that is efficient? Explain your answer.

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 United States has a Mixed Capitalist Economy.

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: • 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 NutshellThe 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.

Q & AQ & A

• What are the three economic questions every society must answer?

• How do Capitalists and Socialists view exchange?

• How do Socialists and Capitalists view Government?