1. Chapter 2 Economic Activities: Producing and Trading

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

3. 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 Elizabeth Apples Elizabeth Bread 200 10 020 Brian ApplesBrian Bread 010 155 300

4. 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

5. 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 Elizabeth Apples Elizabeth Bread 200 10 020

6. 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 Brian Apples Brian Bread 010 155 300

7. 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

8. 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)

9. Brian Bread –8 loaves (0 + 8 traded) Brian Apples –18 apples (30 -12 traded) Are they better off??

10. No Specialization or Trade Specialization and Trade Gains from trade Elizabeth Bread Elizabeth Apples Brian Bread Brian Apples

11. Are they better off?? No Specialization or Trade Specialization and Trade Gains from trade Elizabeth Bread 10 Elizabeth Apples 10 Brian Bread 5 Brian Apples 15

12. Are they better off?? No Specialization or Trade Specialization and Trade Gains from trade Elizabeth Bread 1012 Elizabeth Apples 1012 Brian Bread 58 Brian Apples 1518

13. Are they better off?? No Specialization or Trade Specialization and Trade Gains from trade Elizabeth Bread 1012+2 Elizabeth Apples 1012+2 Brian Bread 58+3 Brian Apples 1518+3

14. Both are Better off!!

15. Can you do it?? United StatesUnited Kingdom ClothingFoodClothingFood 400600 20 3010 040020 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?

16. 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?

17. 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

18. 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

19. 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

20. 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 (can’t charge more or less than a certain price)

21. Now we want to use these questions for the next chapter as we look at: What a market is and how is it established.

22. Homework #3 Chapter 2 Questions 1, 5, 12, and 17 Working with Graphs and Numbers: 1, 2, and 5

23. In-class exercise 3 Do we understand Chapter 2?