So now let's talk about the terms for the trade. What is the correct price to set for the exchange? So first off, for trade to be beneficial to both trading partners, the price of the trade must lie between their opportunity costs. That is the only way that the trade will be beneficial. Here I've got the graphs of your and your friends' parties with the hunch punch and the pizza rolls, and we've got the opportunity cost that we had solved for in a previous video. Right? We knew who had the comparative advantage in each one, right? Whoever has the lower opportunity cost, but now how do we say what the trade should be, right? Should we trade at 1 hunch punch for 1 pizza roll? Is that fair? 2 hunch punches for 1 pizza roll, 3 hunch punches for 1 pizza roll. Where is the correct amount of the trade? Okay, so what's going to happen is we're going to have a range that is okay for the trade. Anywhere within this range, the trade will be beneficial to both. Where we set ourselves in this range comes down to some other factors, but first let's set what the range would be. So remember, it has to lie between the opportunity costs. So the price of the trade in this situation has to lie between 1 hunch punch and 2 hunch punches. Right? Let's say the price of the trade was 2 hunch punches for 1 pizza roll. Why would you even want to trade, right? You can already do that yourself. You would need to be getting something a little better than 2 hunch punches for 1, to even consider it. Right? You'd want to be getting 1.5 or something like that or even 1 if you could, but if you wanted 1 hunch punch for one pizza roll, your friend would say, hey, that's not fair. I could do that myself. Right? My opportunity cost is 1 hunch punch. So for it to be beneficial to both, it's got to lie somewhere in between those two numbers. So it would have to be something like 1.5 like we had in our previous example or 1.2 or 1.8, right? It could be anywhere in this range and it would be beneficial to both parties. It's just where do we end up. So let's see the same thing with the price of the trade for hunch punch and we're saying how many pizza rolls for 1 hunch punch. Well in this situation, it would have to lie between half a pizza roll per hunch punch and 1 pizza roll per hunch punch, right? Same logic here. You wouldn't want to make the trade unless it was in between that range or both people wouldn't want to make the trade, right? So why was the trade set to 1.5 hunch punches per pizza roll before? Why did that number come up? Well first off it was right in the middle, right? So that was one reason it could have ended up thicker, but there are other factors that can come into play. Right? The supply and demand of pizza rolls and hunch punch. What if pizza rolls are really rare and hunch punch is just everywhere? You can just get hunch punch at any old 711. The value of a hunch punch isn't as great, right, so that could affect where the price of the trade would be. How about negotiating power? Just one person's a better negotiator, they might get a trade better in their favor, and the last thing here, equity. They could try and make an equitable trade where everybody is better off. Set. Alright. Let's move on.
2. Introductory Economic Models
PPF - The Price of the Trade
2. Introductory Economic Models
PPF - The Price of the Trade - Video Tutorials & Practice Problems
Now that we have decided to trade, how do we set the correct amounts to trade? Let's make a deal!
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concept
The Price of the Trade
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