Ch. 2: Trade, Tradeoffs, and
Economic Systems
The Production Possibilities
Frontier (PPF)
• The PPF is a graph representing the
possible combinations of two goods that
an economy can produce in a certain
period of time under the conditions of a
given state of technology, all resources are
employed, and production is efficient.
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.
Q&A
• What does a straight-line production possibilities
frontier (PPF) represent? What does a bowedoutward PPF represent?
• In an economy, is there only one combination of
goods that is efficient? Explain your answer.
Exchange or Trade
• Why do people trade?
• To make themselves better off.
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.
Trade and Terms of Trade
• Trade is the process where things (money,
goods, services, and so on) are traded or
exchanged.
• Terms of Trade refer to how much of one
thing is traded for how much of something
else.
• Buyers prefer lower prices, sellers prefer
higher prices.
Trades and Third Parties
• Third Party Effects:
someone other than
the parties involved in
the exchange was
affected.
• If the Third Party
Effect had a negative
effect, this exchange
effect is known as
negative externality.
Q&A
• 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?
Production and Trading
• Remember, Trading is a Utility-Increasing
Activity!
• Barter is exchanging one good for another:
for example, trading apples for bread.
• 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, the trading it for another utility can
increase gains for both parties!
Q&A
• 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 your answers.
Economic Systems
• The way in which society decides what
goods to produce, how to produce them,
and for whom they will be produced.
• 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?
Economic
Questions
Economic Systems and the PPF
• 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.
Mixed
Capitalist
Economies
• An economic system
characterized by largely
private ownership of
factors of production,
market allocation of
resources, and
decentralized decision
making. Most activities
take place in the private
sector in this system, but
government plays a
substantial and regulatory
role.
• The United States has a
Mixed Capitalist Economy.
Trade
• Under Capitalism, both parties benefit from the
trade.
• Under Socialism, Trade is viewed as making one
person better off at the expense of another
person.
Prices
Under a Capitalist
System:
• Prices ration goods
and services
• Prices Convey
Information
• Prices Serve as an
Incentive to Respond
to Information