1 Chapter 2 Some Tools of the Economist

2 Overview How trade creates value How trade creates value The importance and incentives of property rights The importance and incentives of property rights The production possibilities curve The production possibilities curve The law of comparative advantage The law of comparative advantage Capitalism vs. Socialism Capitalism vs. Socialism

3 Is trade a zero-sum game?

4 Trade Creates Value Because the value of goods is subjective, voluntary trade creates value Ex. The Candy Game!

5 Trade Creates Value How trade creates value… 1. When individuals engage in voluntary exchange, both parties are made better off 2. By channeling goods and resources to those who value them most, trade creates value and increases the wealth created by a society’s resources.

6 How Trade Leads to Economic Progress 1. Gains from specialization and division of labor 2. Gains from mass production methods 3. Gains from innovation

7 Creation of Wealth The process by which some people become rich will make everybody richer. Ex. Bill Gates Wrong Right!

8 Transaction Costs Transaction Costs: The time, effort, and other resources needed to search out and complete an exchange.

9 Transaction Costs Leaves a role for middleman.... Middleman: A person who buys and sells goods or services or arranges trades. A middleman reduces transaction costs.

10 Importance of Property Rights Private property rights involve: 1. The right to exclusive use of the property 2. Legal protection against invasion from other individuals 3. The right to sell, transfer, exchange, or mortgage the property

11 4 incentives of property rights 1. Incentive to use resources in ways that are considered beneficial to others. ex. Empty lot ex. Empty lot owners bear the cost of ignoring the wishes of others. ex. Neutral colors

12 4 incentives of property rights 2. Private owners have an incentive to care for and manage what they own ex. How do you drive a rental car compared to your own car? ex. Berry’s Bikes

13 4 incentives of property rights 3. Private owners have an incentive to conserve for the future ex. Popcorn at the movies

14 4 incentives of property rights 4. Private owners have an incentive to make sure their property does not damage your property ex. Keeping your dog on a leash

15 Private Property Rights

16 Property Rights and Development Lack of property rights = lack of economic progress

17 Production Possibilities Curve (PPC) PPC: outlines all possible combinations of total output that could be produced, assuming a: 1. fixed amount of productive resources 2. given amount of technical knowledge 2. given amount of technical knowledge 3. full and efficient use of resources 3. full and efficient use of resources

18 Production Possibilities Curve (PPC) The slope of the curve indicates the amount of one good that must be given up to produce more of the other good. Slope = rise / run

19 Production Possibilities Curve (PPC) A PPC is bowed outward because of the concept of increasing opportunity costs ex. exercise ex. cleaning your room

20 Production Possibilities Curve (PPC) ex. Partying vs. Studying 1. Efficient points 2. Inefficient points 3. Unattainable points 4. How much is produced at a certain point 5. What is given up when moving from one point to another

21 Production Possibilities Curve (PPC) Practice: Can you identify the points? Can you identify the points? How much is being produced at point C? How much is being produced at point C? Describe what happens when you move from point C to point E. Describe what happens when you move from point C to point E.

22 4 factors that shift the PPC curve 1. A change in the economy’s resource base Investment: the purchase, construction, or development of resources However, investment requires us to give up consumption goods ex. Consider the two PPCs (pg. 41)

23 Investment: Shifting out the PPC

24 4 factors that shift the PPC curve 2. Changes in technology technology: the knowledge available in an economy at any given time. Technology determines the amount of output we can generate with our limited resources.

25 4 factors that shift the PPC curve 3. A change in the rules under which the economy functions ex. Development of a system of patents ex. The Jim Crow laws ex. The Jim Crow laws

26 4 factors that shift the PPC curve 4. Changes in work habits ex. working harder can shift curve outward ex. working less can shift curve inward

27 Law of Comparative Advantage The total output of a group of individuals, an entire economy, or a group of nations will be greatest when the output of each good is produced by whoever has the lowest opportunity cost. ex. Should LeBron James clean his own house? ex. Who should mow the lawn ex. Who should mow the lawn

28 Economic organization Every economy faces 3 questions: 1. What will be produced? 2. How will it be produced? 3. For whom will it be produced? ex. Remember the candy game ex. Remember the candy game

29 Economic organization Socialism: a system of economic organization where: 1. Ownership and control of the means of production rest with the state 2. Resource allocation is determined by centralized planning Collective decision making: the method of organization that relies on public sector decision making to resolve basic economic questions.

30 Economic organization Capitalism: A system of economic organization where: 1. Productive resources are owned privately 2. Goods and resources are allocated through market prices Market organization: a method of organization in which private parties make their own plans and decisions with the guidance of market prices

31 Economic organization Why capitalism tends to work (and socialism does not): 1. Capitalism is similar to natural selection. It uses the idea of market efficiency 2. Socialism suffers from an information problem.

32 Review 1. Understand the concept of opportunity cost 2. Know how trade creates value and leads to economic progress. 3. What are the 4 incentives of property rights 4. Be able to read a PPC graph and identify the points.

33 Review 5. What are the four factors that shift the PPC curve 6. What is the law of comparative advantage 7. What are the three questions every economy faces 8. Know the difference between capitalism and socialism and why capitalism works