Trade-offs

Examples of Trade-offs in the following topics:

• The Short-Run Phillips Curve

  • The short-run Phillips curve depicts the inverse trade-off between inflation and unemployment.
  • The long-run Phillips curve is a vertical line that illustrates that there is no permanent trade-off between inflation and unemployment in the long run.
  • Nowadays, modern economists reject the idea of a stable Phillips curve, but they agree that there is a trade-off between inflation and unemployment in the short-run.
  • The idea of a stable trade-off between inflation and unemployment in the long run has been disproved by economic history.

• Introducing the Budget Constraint

  • In this circumstance the decision is easy, and the trade off will be sacrificing convenience and high quality food for the ability to have enough food on the table over the course of the whole month.
  • To expand upon this definition further, the business concept of opportunity cost via trade-offs is a central building block in understanding budget constraints.
  • Understanding these trade-offs underlines the true function of budget constraints in economics, which is identifying which consumer behaviors will maximize utility.
  • This demonstrates the trade-off ratio between the two available products or services.
  • Keep in mind that moving from one point on the in to another is trading off '$x$' amount of one good for '$y$' amount of another.

• Scarcity Leads to Tradeoffs and Choice

  • Your scarce resources force you to make a choice and a trade-off producing one product or another.
  • The concept of trade-offs due to scarcity is formalized by the concept of opportunity cost.

• Shifting the Phillips Curve with a Supply Shock

  • In the long-run, there is no trade-off.
  • Thus, the Phillips curve no longer represented a predictable trade-off between unemployment and inflation.

• The budget constraint: balancing income, consumption, and saving across time

  • Most choices require decision-makers to trade-off costs and benefits at different points in time, which greatly influences how agents make decisions.
  • However, most choices require decision-makers to trade-off costs and benefits at different points in time .
  • In mid-life however, these expenditure patterns begin to level off and are supported or perhaps exceeded by increases in income.
  • In this stage of life, the individual dis-saves, or lives off past savings until death.

• Exchange Rate Policy Choices

  • A government should consider its economic standing, trade balance, and how it wants to use its policy tools when choosing an exchange rate regime.
  • Unfortunately, there is no system that can achieve every possible beneficial outcome; there is a trade-off no matter what regime a nation picks.
  • Flexible exchange rates serve to adjust the balance of trade.
  • When a trade deficit occurs in an economy with a floating exchange rate, there will be increased demand for the foreign (rather than domestic) currency which will increase the price of the foreign currency in terms of the domestic currency.
  • That in turn makes the price of foreign goods less attractive to the domestic market and decreases the trade deficit.

• Trade Leads to Gains

  • Producers and consumers trade because the exchange makes both parties better off.
  • Producers and consumers trade because the exchange makes both parties better off.
  • The sum of consumer and producer surplus is called economic, or social, surplus, and reflects the total amount of benefit received by society when consumers and producers trade.
  • An allocation of resources is Pareto efficient when it is impossible to make any one individual better off without making at least one individual worse off.
  • Similarly, an action that makes at least one party better off without making any individual worse off is called a Pareto improvement.

• Relationship Between Specialization and Trade

  • Specialization refers to the tendency of countries to specialize in certain products which they trade for other goods, rather than producing all consumption goods on their own.
  • Countries produce a surplus of the product in which they specialize and trade it for a different surplus good of another country.
  • However, specializing in the product for which they have a comparative advantage and then trading would allow both countries to consume more than they would on their own.
  • There is one case in which countries are not better off trading: when both face the same opportunity costs of production.
  • In this case, specialization and trade will result in exactly the same level of consumption as producing all goods domestically.

• Voluntary Exchange

  • It is assumed that an individual who voluntarily enters into an exchange would not make himself or herself "worse off."
  • Therefore, any voluntary exchange will increase the welfare of one or both parties and neither will be any worse off.
  • If it is established that on average, 1 cola trades for 5 tea bags, individuals who do not like cola will be willing to accept cola on trade because they know its will trade for tea.
  • If one cola will trade for 5 tea bags,
  • Therefore if Joan voluntarily buys a cola from John (who voluntarily sells it) they are both "better off" or have increased their utility.

• The Importance of Factor Prices

  • These entities will then trade the goods they produce for the items that it would be expensive for them to produce.
  • Therefore, the country is better off importing those goods.
  • Trade and comparative advantage are why factor prices are so important in determining what a country produces.
  • Trade allows a country to produce only what is comparatively cheaper for them to manufacture because they can get everything else they need through trade.