Department of Economics, NSU

Semester: Spring 2013

ECO 101 (NMh) - Chapter 2 (2nd half)
1. Exchange or trade
- The process of giving up one thing for something else. Why do we do it?
- Time periods relevant to trade:

Before the trade: ex ante position

At the point of trade
After the trade: ex post position

2. Terms of trade
- Trade is giving up something for something else, but we need to quantify it.
- Definition: how much of one thing is given up for how much of something else
- 10 taka for a cup of tea
- Bargaining at Nilkhet
3. Cost of Trades
- Example from book: Mustang. The Buyer is willing to pay up to $30k and the seller is willing
to accept $23k. Suggest a term of trade that makes this trade plausible. Why might this trade not
take place?
- Transaction costs: The costs incurred in carrying out a trade or exchange. E.g. the time and
effort needed to search out and negotiate with the other trader.
- Listing in the paper: $10k (can include opportunity cost of time)
- Will trade take place?
4. Role of an entrepreneur
- Turning potential trades into actual trades. E.g. Retail stores. Why don't we buy rice from
farmers, and go to kachabazar or Agora instead?
- Example from book
5. Negative externalities

- Trade doesn't make everyone better off (sometimes even a seller or a buyer is not actually
better off).
- If a good has a negative externality, then the cost to society is greater than the cost consumer is
paying for it.
6. Production, Trade and Specialization
- Let us consider a barter economy (i.e. no money or medium of exchange)
- Exhibit 8, page 43. Draw PPF.
- Instead of producing both goods, does specialization and trading make them both better off? let
us check.
- Brian has absolute advantage in the production of apples and Elizabeth in Bread. Absolute
advantage is present when someone can produce a good more efficiently than the other person
given the amount of resources.
- The principle of absolute advantage states that each should produce the good they have
absolute advantage in.
- Exhibit 9 shows both of them are better off.
- What if either Elizabeth or John had an absolute advantage in both goods, i.e. the situation
where someone can produce both goods more efficiently using the given resources? Will trade
take place?
- Comparative advantage: The situation where someone can produce a good at a lower
opportunity cost than the other person.
- What terms of trade will ensure an exchange?
- Profit and a lower cost of living (profit does not have to come at another's expense).
- What if there are transaction costs?
7. Benevolent dictator and the Invisible Hand
- Acting in self-interest leads people to the same outcome as a benevolent dictator would (is this
always true?)
ANNOUNCEMENT
Quiz next class (Wednesday 6th of February, 2013) on Chapters 1 and 2. It will be 40
minutes long, and held in class. No lectures will be held after the quiz. Bring your NSU ID.