An individual's production possibilities depend upon individual skill, the tools available to the individual, training and acquired skills, work effort, and the technology that combines ability, skills, tools, and resources. Because these differ for different individuals, individuals will typically have different opportunity costs.
The ability to produce, the possible choices, and their costs can be represented by a production possibilities frontier. A PPF indicates the maximum amount that can be produced of any particular mix of goods and services.
Teams are often more productive than individuals working alone. However, team production creates opportunities for individual workers to shirk. Shirking can be reduced, and the substantial gains from team production realized, if some people monitor the work effort of others. Since these monitors have, in turn, incentives to shirk ,firms are organized where there is a hierarchy of monitors. Thus, the typical pyramidal organization of a firm evolved to reduce or minimize the shirking problem. Likewise, the rich array of compensation schemes (e.g., wages, salaries, commissions, tips, bonuses, stock options, etc.) evolved as ways to eliminate or reduce the costs of shirking and monitoring. If the quantity demanded is greater than the quantity supplied at a particular price, there is excess demand. If the quantity demanded is less than the quantity supplied at a particular price, however, there is excess supply. If the market price increaes when there is excess demand, and decreases when there is excess supply, a market coordinates the differing interests of demanders and suppliers. Specifically, the price moves to equate the quantity that suppliers willingly provide to the market with the quantity that demanders want to purchase. When the price is such that there is neither excess demand nor excess supply, the amount that demanders wish to purchase will be equal to the amount that suppliers wish to sell: the market is in equilibrium at that price.
Changes in the desires of either suppliers or demanders will lead to predictable changes in price:
1. An increase in demand, if nothing else happens, will lead to an increase in the market price.
2. An increase in supply if nothing else happens will lead to a decrease in the market price.
3. A decrease in demand, if nothing else happens, will lead to a decrease in the market price.
4. A decrease in supply, if nothing else happens, will lead to an increase in the market price.
An appreciation of an economy's currency in foreign exchange markets will make its exports appear more costly to foreigners and, generally, its exports will fall. Also, as just noted, an appreciation also makes imports from abroad appear less costly to domestic citizens, and, as a consequence, imports will increase. The combined effects of an appreciation, then, is that net exports will fall. If a country has balanced trade--that is, net exports are zero--then it will find itself with a trade deficit (net exports will be less than zero). If a country has a trade surplus--that is, its net exports are positive--the effect of the appreciation will be to reduce the size of the surplus.
A depreciation of an economy's currency in foreign exchange markets will have the opposite effect: net exports will increase. In this case, an economy with balanced trade will find that now has a trade surplus; one with a trade deficit will find that the deficit falls or is eliminated.
It follows that if a country's currency appreciates when it is running a trade surplus, the appreciation will tend to eliminate the surplus and if depreciation occurs when there is a trade deficit, the depreciation will tend to eliminate the deficit. For this reason, net exports can be persistently different from zero (e.g., negative) only if individuals in one economy choose to hold the currency or assets of another economy.