Chapter 2
Some Tools of the Economist
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Overview
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How trade creates value
The importance and incentives of property
rights
The production possibilities curve
The law of comparative advantage
Capitalism vs. Socialism
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Is trade a zero-sum game?
3
Trade Creates Value
Because the value of goods is subjective,
voluntary trade creates value
Ex. The Candy Game!
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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.
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How Trade Leads to Economic
Progress
1. Gains from specialization and division of
labor
2. Gains from mass production methods
3. Gains from innovation
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Creation of Wealth
The process by which some people become
rich will make everybody richer.
Ex. Bill Gates
Wrong
Right!
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Transaction Costs
Transaction Costs: The time, effort, and
other resources needed to search out and
complete an exchange.
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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.
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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
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4 incentives of property rights
1. Incentive to use resources in ways that
are considered beneficial to others.
ex. Empty lot
owners bear the cost of ignoring the
wishes of others.
ex. Neutral colors
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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
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4 incentives of property rights
3. Private owners have an incentive to
conserve for the future
ex. Popcorn at the movies
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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
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Private Property Rights
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Property Rights and Development
Lack of property rights = lack of economic
progress
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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
3. full and efficient use of resources
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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
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Production Possibilities Curve
(PPC)
A PPC is bowed outward because of the
concept of increasing opportunity costs
ex. exercise
ex. cleaning your room
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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
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Production Possibilities Curve
(PPC)
Practice:
 Can you identify the points?
 How much is being produced at point C?
 Describe what happens when you move
from point C to point E.
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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)
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Investment: Shifting out the PPC
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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.
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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
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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
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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
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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
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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.
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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
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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.
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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.
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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
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