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5.5 End-of-Chapter Material

In Conclusion

This chapter is our first look at how individuals exchange. We have emphasized two points:

  1. How individuals trade. You have seen that some very familiar things, such as eBay and craigslist, provide mechanisms to facilitate trade.
  2. Why individuals trade. These gains may simply arise from differences in how people value items, as in Chapter 5 "eBay and craigslist", Section 5.2 "eBay". Or, as in Chapter 5 "eBay and craigslist", Section 5.5 "End-of-Chapter Material", these gains may reflect the fact that people differ in their abilities to produce different goods and services.

In reality, individuals differ across these two dimensions and more.Chapter 9 "Making and Losing Money on Wall Street" explores two further reasons for trade: differences in information and differences in attitudes toward risk.

Auctions such as eBay, newspaper classified advertisements, and sites such as craigslist are all means by which individuals in an economy can trade with one another. Of course, these are not the only forms of trade. Our discussion, by design, has ignored other common forms of trade in the economy, such as individuals buying goods and services from a firm (perhaps through a retailer) and individuals selling their labor services to firms.Such exchanges are discussed in Chapter 6 "Where Do Prices Come From?" and Chapter 7 "Why Do Prices Change?".

The biggest insight you should take away from this chapter is the fact that exchange is a means of creating value. When a seller sells a good or a service to a buyer, there is a presumption that both become better off. We have such a presumption because people enter into trades voluntarily: nobody forces a buyer to buy; nobody forces a seller to sell. The fact that voluntary exchange creates value is one of the most powerful ideas in economics.

Key Links

Exercises

  1. Would you expect to get an item for less by buying it through craigslist rather than a regular store? If so, why?
  2. (Advanced) Suppose the government imposed a tax on trading through craigslist, so the seller had to pay 5 percent of the price to the government. What might be the impact on trade in this market? What might happen to prices?
  3. If you are a seller on craigslist, what would be the cost of setting a very high price?
  4. If the price of an item traded increases, can both the surplus to the buyer and the surplus of the seller increase simultaneously?
  5. If the owner of a car values it at $5,000 and there is a prospective buyer who is willing to pay $7,000 for that car, what does efficiency dictate about the price the buyer should pay for the car?
  6. What are the differences between buying an item on eBay and buying that same item on craigslist?
  7. In what settings do you have to be aware of the winner’s curse?
  8. In what way does a double oral auction differ from craigslist? From eBay?
  9. If more people come into an auction, how should that affect your bidding in a winner’s curse situation? Should you bid more or less? Why?
  10. Suppose that instead of producing 2 vegan meals each hour, Julio can produce 3 vegan meals each hour. Draw his production possibilities frontier. What is his opportunity cost of web pages in terms of vegan meals with this alternative technology?
  11. Suppose that Julio can produce 3 vegan meals each hour but requires 2 hours to design a web page. Draw his production possibilities frontier.
  12. If Julio had a choice between the technology in Table 5.2 "Julio’s Production Ability" and the one described in question 10, which would he prefer? Explain why.
  13. What would the production possibilities frontier look like if, starting from point A in Figure 5.8 "Why You Should Bid Your Valuation in an eBay Auction", we first shifted Hannah rather than Julio to vegan meal production?
  14. Show how the production possibilities frontier shifts if Hannah becomes more productive in producing web pages.
  15. (Advanced) Suppose that both Julio and Hannah like each of the goods in a ratio of 6 vegan meals to 1 web page. Show that there are still gains to trade using the technologies described in Table 5.1 "Valuations of Different Bidders in a Winner’s Curse Auction".
  16. Explain what it means to “specialize in production and generalize in consumption.” How many jobs do people usually have at a point in time? How many items does a food shopper usually have in his or her basket at the store?
  17. Explain the connection between opportunity cost and comparative advantage.

Economics Detective

  1. Find an auction to buy or sell the following items: a house, a car, a government bond, and licenses for the electromagnetic spectrum. What do you have to do to become a bidder at one of these auctions? How is the auction conducted?
  2. Suppose you want to purchase a painting at Sotheby’s, a famous English auction house. How would you do so? How would the auction operate? In what ways would it differ from buying art on eBay or craigslist?

Spreadsheet Exercise

  1. (Advanced) Create a spreadsheet to input data like that in the first two columns of Table 5.4 "Production Possibilities for Julio and Hannah". Suppose there are two people who can produce two goods. Enter into the spreadsheet how much of each good they can produce in an hour.

    1. Calculate the opportunity costs, as in the last two columns of Table 5.4 "Production Possibilities for Julio and Hannah".
    2. Assuming each has 8 hours a day to work, use the spreadsheet to calculate the total amount of each good each individual could produce if they produced only that good.
    3. Use this information to graph the production possibilities frontier for each person.
    4. Use this information to graph the production possibilities frontier for the two people combined.
    5. As you input different levels of output per hour per person, watch how these graphs change.
    6. Where do you see comparative advantage coming into play?