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Chapter 2

ECO-2013 Chapter Notes - Chapter 2: Berry College, Ebay, Opportunity Cost

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Joseph Calhoun

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Chapter 2: Some Tools of the Economist
I. Trade Creates Value
a. Physical value (price), not subjective value
b. When individuals engage in a voluntary exchange, both parties are made better off
i. “but trading does not create new material items and therefore, cannot generate
gain” fallacy
ii. Voluntary trades make both parties better off
c. By channeling goods and services to those who value them most, trade creates value and
increases the wealth created by a society’s resources
i. Society’s total value increases
ii. Trade creates wealth for both trading partners and the nation
d. Transaction Costs A Barrier to Trade
i. Transaction Cost- the costs of the time, effort, and other resources necessary to
search out, negotiate, and conclude an exchange (e.g. cost of gas to drive to a
cheaper store)
ii. Reductions in transaction costs will increase the gains from trade (e.g. the
Internet; eBay)
e. The Middleman as a Cost Reducer
i. Middlemen- people who buy and sell goods/services or arrange trades and lowers
transaction costs (e.g. an auto dealer, stockbrokers, realtors, grocers, etc.)
II. The Importance of Property Rights
a. Property Rights- the rights to use, control, and obtain the benefits from a good/resource
b. Private-property Rights- property rights that are exclusively held by an owner and
protected against invasion by others. Private property can be transferred, sold or
mortgaged at the owner’s discretion. 3 rights:
i. exclusive use/sole possession
ii. legal protection against invasion
iii. right to transfer, sell, exchange or mortgage the property
c. Common-property Ownership- beaches, parks; “when everybody owns it, nobody owns
d. 4 incentive effects that private ownership generates:
i. Private owners can gain by employing their resources in ways that are beneficial
to others and they bear the opportunity cost of ignoring the wishes of others (e.g.
painting the walls of your house purple because you can vs. painting them neutral
colors in case you resell the house later)
ii. Private owners have a strong incentive to care for and properly manage what they
own (e.g. the Berry College communal bikes destroyed)
iii. Private owners have an incentive to conserve for the future particularly if that
property is expected to increase in value (e.g. drilling from a communal hole for
oil you will try to get as much as possible, as quickly as possible vs. if it’s your
own hole, you can take your time since no one else can touch it)
iv. Private owners have an incentive to lower the chance that their property will
cause damage to the property of others (e.g. car accident)
e. Private Ownership and Markets
i. Market prices give private owners a strong incentive to consider the desires of
others and use their resources in ways others value
ii. “The Extended Order- tendency for markets to lead perfect strangers from
different backgrounds around the world to cooperate with one another
iii. “The Mystery of Capital” by Hernando de Soto – argues that some countries lack
economic progress because they lack private ownership (no motivation to
provide goods/services since their land can be taken/given away freely)
iv. Cool idea- protecting endangered species with private ownership
III. Production Possibilities Curve
a. Production Possibilities Curve- a curve that outlines all possible combinations of total
output that could be produced, assuming 1.) a fixed amount of productive resources, 2.) a
given amount of technical knowledge, and 3.) full and efficient use of those resources.
The slope of the curve indicates the amount of one product that must be given up to
produce more of another
b. Whenever more of one thing is produced, there is an opportunity cost!
c. Shifting the Production Possibilities Curve Outward
i. An increase in the economy’s resource base would expand our ability to produce
goods and services (e.g. machinery, buildings)
1. Investment- the purchase/construction/development of resources,
including physical assets, such as plants and machinery, and human
assets, such as better education. Investment expands an economy’s
resources. The process of investment is sometimes called, “capital
2. The choice between using resources to produce other goods for current
consumption vs. using them for the future
ii. Advancements in technology can expand the economy’s production possibilities
1. Technology- the technological knowledge available in an economy at
any given time. The level of technology determines the amount of output
we can generate with our limited resources
2. Innovation- practical and effective adoption of new technologies
a. Carried out by an entrepreneur- person who introduces new
products/improved techniques to satisfy customers at a lower
3. “Creative Destruction”- replacement of old products and production
methods by innovative new ones that consumers judge to be superior
economic growth and higher living standards
iii. An improvement in the rules under which the economy function scan also
increase output
1. Legal system affects economy (private property rights; patents)
2. E.g. in the 1800s, southern states refused to hire African Americans and
severely hurt their own economy (because they were racist idiots)
iv. By working harder and giving up leisure, we could increase our production of
goods and services
d. Production Possibilities and Economic Growth
i. Economic growth = outward shift on curve
ii. Production possibilities curve is foundation for other economic models
IV. Trade, Output, and Living Standards
a. Specialization and division of labor, large-scale production, and the dissemination of
better products and production methods
b. Division of Labor- a method that breaks down the production of a product into a series of
specific tasks, each performed by a different worker
c. Gains from Specialization and Division of Labor
i. Law of comparative advantage- a principle that states that individuals, firms,
regions, or nations can gain by specializing in the production of goods that they
produce cheaply (at a low opportunity cost) and exchanging them for goods they
cannot produce cheaply (at a high opportunity cost)
d. Gains From Mass Production Methods
i. Mass production = lower per-unit costs
ii. Labor and machinery efficiencies that increase the output per worker
e. Gains From Innovation
i. Discovery has meaning with innovation
ii. Adaptation of technology from other nations
V. Human Ingenuity and the Creation of Wealth
a. “Economic pie” divided by each member in society
b. Important point in a market economy, a larger income for one person does not mean a
smaller income for a trading partner. It is the exact opposite (e.g. Bill Gates’ software has
expanded the economic pie for everyone)
VI. Economic Organization
a. Every economy faces 3 questions:
i. What will be produced?
ii. How will it be produced?
iii. For whom will it be produced?
b. 2 types of economies: markets and government (political) planning
c. Market Organization
i. Market Organization- a method of organization in which private parties make
their own plans and decisions with the guidance of unregulated market prices.
The basic economic questions of consumption, production, and distribution are
answered through these decentralized decisions
ii. Capitalism- an economic system in which productive resources are owned
privately and goods and services are allocated through market prices
iii. Government is not an active player in the economy
d. Political Organization
i. Collective Decision-Making- the method of organization that relies on public-
sector decision-making (voting, political bargaining, lobbying and so on) to
resolve basic economic questions
ii. Socialism- a system of economic organization in which 1.) the ownership and
control of the basic means of production rest with the state and 2.) resource
allocation is determined by centralized planning rather than market forces
1. The decide to expand or contract commodities