Why does exchange create wealth? One person’s trash is another’s treasure. Peoples evaluation of goods and services are –subjective and –different.
The Principle of Exchange (an application of benefit/cost analysis) People will exchange if they expect to gain more than they give --- if the expected benefit is greater than the expected cost.
Voluntary Exchange No Rip Offs! When agreeing to exchange, both parties expect to gain more than they give.
The Gasoline Rip Off Gasoline prices are ridiculous; international oil companies are ripping you off! Did you buy the gas? Why did you buy the gas? Using marginal analysis, you compared the benefits of coming to school to the opportunity cost of the funds used to buy the gas. The benefits outweighed the cost! You gained more than you gave. The gas station owner gained also.
When it doesn’t work Lack of information Misinformation -- fraud Asymmetric information – buyers and sellers have different access to information; one trader has more or better information than the other
Employment as Voluntary Exchange Employers must gain “I hate my job!” Use marginal benefit/cost analysis to explain: –Why an employer would let an employee go; why an employee might choose to leave her/his job.
Education as Voluntary Exchange You are voluntarily exchanging your money and your human capital for this class. Why? Many high school students don’t expect to gain from school. How does that affect the nature of the exchange?
Voluntary Exchange Creates Wealth. Wealth is the subjective evaluation of well being. After voluntary exchange, both parties should have a higher evaluation of their well being than before the exchange. They gave up something of less value than they gained. If two people voluntarily exchange, wealth is created.
Barter exchanges are inefficient. Barter – exchanging goods for goods Must have mutual coincidence of wants –You have to want what I have and I have to want what you have. –Otherwise we might have to make many transactions before getting the thing we want.
Transaction Cost Opportunity costs of facilitating exchange –Searching for the product (search cost) –Arranging for the exchange –Agreeing to the terms of exchange –“Dead weight loss” In exchange, your cost is someone’s gain. With transaction cost, your cost is no one’s gain.
Money A way of exchanging personal resources for goods and services –You are a carpenter –You exchange your human capital for money –You exchange money for goods and services –You exchanged your human capital for goods and services
You provide your human capital to a firm; the firm provides you with money.
You provide money to the grocer, you get the goods and services you desire.
Money is a tool for exchanging resources you own for goods and services you want.
Money minimizes transaction cost. No need for mutual coincidence of wants. –You sell what you have to someone who wants it. –You get money. –You use the money to buy what you want. –The person selling what you want does NOT have to want what you produce.
Further reduction of transaction costs. Credit and debit cards ATM’s The Internet Direct deposit Posting menus outside restaurants
Main Points Because peoples’ evaluations of goods and services are subjective and different, both parties can benefit from exchange, increasing wealth. The Principle of exchange – people will exchange if they expect to gain more than they give. When people voluntarily exchange, there are no ripoffs.
Main Points Assymetric information reduces the probability that both parties will benefit from exchange. Transaction costs –opportunity costs involved with exchange –dead weight losses –include search costs Money facilitates exchange by reducing transaction costs.