Ch. 2: Economic Activities: Producing and Trading

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Ch. 2 Economic Activities Producing and Trading
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The Production Possibilities Frontier (PPF)

• Represents the possible combination of two goods
  that can be produced in a certain period of time
  under the conditions of
• A given state of technology
• Fully employed resources

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Exhibit 1 Production Possibilities
Frontier(Constant Opportunity Costs)
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Exhibit 2 Production Possibilities
Frontier(Constant Opportunity Costs)
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Law of Increasing Opportunity Costs

• Law of Increasing Opportunity Costs as more of
  a good is produced, the opportunity costs of
  producing that good increase.
• Must employ resources which are less efficient
  and/or appropriate when increasing production.
• In the real world, most PPF lines are bowed
  outward.

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Exhibit 3 A Summary Statement About Increasing
Opportunity Costs and a Production Possibilities
Frontier that is Bowed Outward (Concave Downward)
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Economic Concepts Within a PPF Framework

• Scarcity
• PPF graphically portrays finite resources.
• PPF separates production possibilities into
  attainable and unattainable regions.
• Choice and Opportunity Cost
• Choices must be made between attainable
  combinations of two goods to produce.
• Choice implies opportunity cost.

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Economic Concepts Within a PPF Framework

• Productive Efficiency the condition where the
  maximum output is produced with given resources
  and technology.
• Implies gains are impossible in one area without
  losses in another area.
• Lie on the production possibilities frontier.
• Productive Inefficiency condition where less
  than the maximum output is produced with given
  resources and technology.
• Implies gains are possible in one area without
  losses in another area.
• Lie inside the production possibilities frontier.

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Exhibit 4 One PPF, Five Economic Concepts
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Economic Concepts Within a PPF Framework

• Technology the body of skills and knowledge
  concerning the use of resources in production.
• Economic Growth increased productive
  capabilities of an economy.
• Economic growth results in an outward shift in
  the PPF.

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Exhibit 5 Economic Growth within a PPF Framework
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Self-Test

• What does a straight-line production
  possibilities frontier (PPF) represent? What
  does a bowed-outward PPF represent?
• What does the law of increasing costs have to do
  with a bowed-outward PPF?
• A politician says, If you elect me, we can get
  more of everything we want. Under what
  condition(s) is the politician telling the truth?
• In an economy, only one combination of goods is
  productive efficient? True of False? Explain.

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Trade or Exchange

• Why do people trade?
• To make themselves better off.

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Self-Test

• Smith is willing to pay a maximum of 300 for
  good X and Jones is willing to sell good X for a
  minimum of 220. Will Smith buy good X from
  Jones?

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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.

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Trade and Terms of Trade

• Trade the process of giving up one thing
  (money, goods, services, etc.) for something
  else.
• Terms of Trade how much of one thing is traded
  for how much of something else.
• Buyers prefer lower prices, sellers prefer higher
  prices.

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Unexploited Trades

• Transaction Costs costs associated with
  searching out, negotiating, and completing an
  exchange.
• 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.

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Trades and Third Parties

• Third Party Effects someone other than the
  parties involved in the exchange was affected.
• Negative Externalities
• Positive Externalities

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Production, Trade, and SpecializationProducing
and Trading

• Barter exchanging one good for another.
• 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,
  then trading it for another utility, can increase
  gains for both parties!

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Exhibit 7 Production by Elizabeth and Brian
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Exhibit 8 Consumption for Elizabeth and Brian
With and Without Specialization and Trade
8 Loaves of Bread 12 Apples
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Production, Trade, and SpecializationProfit and
a Lower Cost of Living

• The desire for Profit and a Lower Cost of Living
  guided the decisions of Elizabeth and Brian.
• Both acted in their own self-interests.
• Both gained from specialization and trade.
• Adam Smith Eighteenth-century economist (the
  father of modern economics) spoke about an
  invisible hand that guided individual actions
  toward a positive outcome that he/she did not
  intend.

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Self-Test

• 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.

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Economic System

• Economic System the way in which society
  decides to answer key economic questionsin
  particular those questions that relate to
  production and trade.

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Economic Questions

• Production
• What goods will be produced?
• How will the goods be produced?
• For whom will the goods be produced?
• Trade
• What is the nature of trade?
• What function do prices serve?

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Economic Systems

• There are hundreds of countries but only two
  major economic systems.
• We refer to these two major systems as Socialism
  and Capitalism.
• Most Countries have chosen elements from BOTH
  economic systems.

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Economic Systems and the PPFWho Decides Where
the Economy Will Operate on the PPF?
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Property Rights

• Property Rights Refer to the laws, regulations,
  rules and social customs that define what an
  individual can and cannot do in society.
• Capitalist and Socialist Systems assign property
  rights differently.
• Property rights impact resource allocation,
  incentives, and behavior.
• Differences in conserving scarce resources.