PPF - Price of the Trade - Online Tutor, Practice Problems & Exam Prep

For trade to be mutually beneficial, the price must fall between the opportunity costs of the trading partners. For example, if trading hunch punch for pizza rolls, the price should be set between 1 and 2 hunch punches per pizza roll. Factors like supply and demand, negotiating power, and equity can influence the final trade price. Understanding these dynamics is crucial for effective exchange and maximizing benefits in trade scenarios.

The Price of the Trade

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, let me get my thin pen, must lie between their opportunity cost, alright, between the opportunity costs of the 2 producers. Alright. That is the only way that the trade will be beneficial. Here I've got the graphs of you and your friends' parties with the hunch punch and the pizza roles, 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 could be making 2 hunch punches for 1 pizza roll without the trade. 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 gotta 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 if we were talking about 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 being chosen, 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 7-Eleven. 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.

Here’s what students ask on this topic:

What is the Production Possibility Frontier (PPF) and how does it relate to opportunity cost?

The Production Possibility Frontier (PPF) is a curve that illustrates the maximum feasible amount of two goods that a country can produce, given its resources and technology. It shows the trade-offs between the two goods. The opportunity cost is represented by the slope of the PPF. When producing more of one good, the opportunity cost is the amount of the other good that must be forgone. This relationship helps in understanding the cost of reallocating resources from one good to another, which is crucial for making efficient production decisions.

How do you determine the correct price for trade between two parties?

To determine the correct price for trade between two parties, the price must lie between their respective opportunity costs. For instance, if one party's opportunity cost of producing a good is lower than the other's, the trade price should be set between these two opportunity costs. This ensures that both parties benefit from the trade. Factors such as supply and demand, negotiating power, and equity can also influence the final trade price. The goal is to find a mutually beneficial price that maximizes the gains from trade for both parties.

What factors influence the final trade price between two parties?

Several factors influence the final trade price between two parties. These include:

• Opportunity Costs: The price must lie between the opportunity costs of the trading partners.
• Supply and Demand: The relative availability of the goods can affect their value and thus the trade price.
• Negotiating Power: A party with stronger negotiating skills may secure a more favorable trade price.
• Equity: Considerations of fairness and mutual benefit can also play a role in setting the trade price.

These factors ensure that the trade is beneficial and acceptable to both parties involved.

Why must the price of trade lie between the opportunity costs of the trading partners?

The price of trade must lie between the opportunity costs of the trading partners to ensure that both parties benefit from the trade. If the price is outside this range, one party would be better off producing the good themselves rather than trading. For example, if one party's opportunity cost of producing a good is 1 unit and the other's is 2 units, the trade price should be between 1 and 2 units. This range ensures that both parties gain more from trading than from producing the good on their own.

How does negotiating power affect the final trade price?

Negotiating power significantly affects the final trade price. A party with stronger negotiating skills or leverage can secure a more favorable trade price. This could be due to better information, stronger alternatives, or greater influence. For example, if one party can convincingly argue for a price closer to their opportunity cost, they can gain more from the trade. Effective negotiation ensures that the trade terms are advantageous, maximizing the benefits for the stronger negotiator while still being acceptable to the other party.