Definition: The Opportunity cost of consuming a good is the value one places on the next best alternative.
Example: The cost of attending Econ 2023
Books 45 Supplies 40
Time (150 hrs) $1500 Assuming $10/hr.
Travel ( 15 Hrs.) $150
Total Costs: $2250
Definition: Transaction cost is the time, effort, and other resources needed to search out, negotiate, and carry out an exchange of goods or services.
It is wrong to assume that a particular good or service has value just because it exists. The microwave oven on the department store shelf is worth more than the one in a warehouse. By getting it to a place where the customer can easily see it and buy it, the distributor has added value to the product.
Definition: Property Right: The right to use, control and obtain the benefits associated with a particular good.
Private Property Right: Exists when the property right is:
The production possibilities curve indicates the rate at which one good can be traded off to produce another good.
Definition: The Law of Comparative Advantage - This economic principle suggests that individuals, firms, regions, states, countries or other economic units can gain by specializing in the production of goods that they produce cheaply (as low opportunity cost producer) and trading for those goods for which they are the high opportunity cost producer.
Consider the production of two goods in two regions of a country. The following is a table which tells us how much of the two goods these regions can produce with their 3available resources.
Comparative Advantage - The producer that produces the good with relatively low opportunity cost has a comparative advantage in the production of that good. Low Cost Producers have comparative advantage.
Steps to take in solving comparative advantage problems
Step 1: You must determine the opportunity cost of producing 1 more unit of each good in each region.
Opportunity cost of Producing 1 more unit of Food:
In Slavia, 2 additional units of food cost 2 units of Beer. Or, 1 more food costs 1 more beer.
In Italia producing 2 more units of food causes production of Beer to fall by 8 units. Hence the cost of 1 more food is 4 units of Beer.
Slavia gives up less beer per unit of food production, so they have comparative advantage in producing Food.
Step 2: As long as opportunity costs differ between the two regions, one will be the relatively low cost producer of one good; the other will have comparative advantage in the other good.
Opportunity cost of Producing 1 more unit of Beer:
In Slavia, 2 additional units of Beer cost 2 units of Food. Or, 1 more Beer costs 1 more Food.
In Italia producing 8 more units of Beer causes production of Food to fall by 2 units. Hence the cost of 1 more Beer is 2/8=1/4 units of Food.
Italia gives up less Food per unit of Beer production, so they have comparative advantage in producing Beer.
Slavia is low cost producer of Food: Italia is the low cost producer of Beer
Joint output of Beer and Food can be maximized if the two regions specialize.
Step 3: Terms of trade describe the range of "prices" at which trade will be mutually beneficial. Compare the opportunity costs from step 2 to determine these.
Terms of trade:
Slavia makes food and demands at least 1 beer for each food it sells. Of course, they would like to get more.
Italia makes Beer and demands at least 1 food for each 4 beers it sells. They will accept no less.
So, the acceptable terms of trade will be somewhere between
1 Food for 4 Beers and 1 Food and 1 Beer.
The costs associated with mutual dependence must be weighed against the benefits of specialization.