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  1. 1. The Magic of Exchange SUBJECTIVELY: where oneperson’s (perceived) trash is another person’s (perceived) treasure.
  2. 2. Pete’s Bat and Sam’s Shoes  Would you consider exchanging these items?
  3. 3. Why (and How) does an exchange create wealth? One person’s trash is another’s treasure. because any one individual’s evaluation of goods and services is  subjective and  different.
  4. 4. The Principle of Exchange as an application of the benefit versus cost analysis People will exchange if they expect to gain morethan they give up --- specifically, if they believe theexpected benefit is greater than their expected cost.
  5. 5. These principles refer to“Voluntary” Exchanges ~ Not Rip Offs!When agreeing to exchange, both parties expect to gain more than they are giving up.
  6. 6. The Gasoline Purchase….. as Rip Off (?) ex ante ~ Gasoline prices are ridiculous; so international oil companies are ripping you off! Did you make the choice to buy the gas? Why did you buy the gas? Using marginal analysis, you compared the benefits of “buying the gas” to the opportunity cost of the using the funds to “do something else you may have wanted to do”. If the benefits outweighed the cost! You gained. nota bene: The gas station owner gained also.
  7. 7. When “benefit/cost” doesn’t work When there is a “lack of information” When there is “misinformation” (or fraud) When there is “asymmetric information”
  8. 8. Employment as Voluntary Exchange Employers must gain Though you say “I hate my job!” (how much) Use marginal analysis to explain:  Why SF Giants might let Barry Bonds go? Why might he decide to leave  Why the SF 49ers let Jerry Rice go? Why did he decide to leave and go to the hated Oakland Raiders?
  9. 9. Education as Voluntary Exchange You are voluntarily exchanging your money and contributing your human capital to this class. Why? Many high school students don’t expect to gain from school. How does that affect the nature of the exchange? TYPE of EXCHANGE(?)
  10. 10. Voluntary Exchanges Create Wealth Wealth is the value people place on their assets ~ both human and non-human. After a voluntary exchange both parties should place a higher value on their “after” assets than their “before” assets. They believe they gave up a “lesser wealth” for a “greater wealth” something. Even if only two people voluntarily exchange, wealth is created.
  11. 11. 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 each of us wants.
  12. 12. Transaction Cost Opportunity Costs are subjective valuations associated  with Searching for the product (search cost)  with Arranging for the exchange  with Agreeing to the terms of exchange  with “Dead Weight Loss”  In an “exchange” your cost is someone’s gain.  With a “Dead Weight Loss” your cost is no one’s gain.
  13. 13. 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  thus You exchanged your human capital for goods and services
  14. 14. You provide your humancapital to a firm and the firm provides you with money.
  15. 15. You provide money to thegrocer and you get the goods and services you desire.
  16. 16. Money is a tool for exchangingresources for goods and services
  17. 17. Money minimizes transaction costs No need for a 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.
  18. 18. Further reductions of transaction costs  Credit and debit cards  ATM’s  The Internet  Direct deposit  Posting menus outside restaurants
  19. 19. Main Points to Consider 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 engage in exchange if they expect to gain more than they have to give up. When people voluntarily engage in an exchange there are no rip-offs = they are efficient?
  20. 20. Main Points to Remember Asymmetric information conditions reduce the probability both parties will benefit from exchange transaction. Transaction costs include  opportunity costs involved with exchange  dead weight losses  search costs Money facilitates exchange by reducing the total of the transaction costs incurred.
  21. 21. ....DEFINITIONS….Asymmetric Information Problem: A problem arisingwhen either buyers or sellers have important action aboutthe product not possessed by the other side in potentialtransactions.Deadweight Loss: A net loss associated with the forgoingof an economic action. The loss does not lead to anoffsetting gain for other participants. It thus reflectseconomic inefficiency.