PPF - The Price of the Trade: Study with Video Lessons, Practice Problems & Examples

For trade to be mutually beneficial, the price must fall between the opportunity costs of the trading partners. This range ensures that both parties gain from the exchange. For example, if the opportunity cost of 1 pizza roll is 1 to 2 hunch punches, a fair trade price could be 1.5 hunch punches per pizza roll. Factors like supply and demand, negotiating power, and equity can influence the final trade price. Understanding these concepts is crucial for grasping market dynamics and achieving an efficient market outcome.

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 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.

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 given up. This concept helps in understanding the efficiency and allocation of resources in an economy.

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

To determine the correct price for trade, the price must lie between the opportunity costs of the two trading partners. This ensures that both parties benefit from the trade. For example, if the opportunity cost of 1 pizza roll is between 1 and 2 hunch punches, a fair trade price could be 1.5 hunch punches per pizza roll. Factors like supply and demand, negotiating power, and equity can also influence the final trade price.

What factors influence the final trade price between two parties?

Several factors influence the final trade price between two parties: 1) Supply and demand: If one good is more abundant, its value may be lower. 2) Negotiating power: A better negotiator can secure a more favorable trade. 3) Equity: Ensuring that both parties feel the trade is fair and beneficial. These factors help determine where within the opportunity cost range the final trade price will fall.

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 exchange. If the price is outside this range, one party would be better off producing the good themselves rather than trading. For example, if the opportunity cost of 1 pizza roll is 1 to 2 hunch punches, trading at 1.5 hunch punches per pizza roll ensures both parties gain from the trade.

How does negotiating power affect the trade price?

Negotiating power affects the trade price by allowing the stronger negotiator to secure a more favorable deal. If one party has better negotiation skills or more leverage, they can push the trade price closer to their preferred end of the opportunity cost range. This can result in a trade price that benefits them more, while still being within the acceptable range for the other party.