The Magic of Exchange SUBJECTIVELY: where oneperson’s (perceived) trash is another person’s (perceived) treasure.
Pete’s Bat and Sam’s Shoes Would you consider exchanging these items?
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.
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.
These principles refer to“Voluntary” Exchanges ~ Not Rip Offs!When agreeing to exchange, both parties expect to gain more than they are giving up.
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.
When “benefit/cost” doesn’t work When there is a “lack of information” When there is “misinformation” (or fraud) When there is “asymmetric information”
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?
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(?)
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.
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.
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.
MoneyA 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
You provide your humancapital to a firm and the firm provides you with money.
You provide money to thegrocer and you get the goods and services you desire.
Money is a tool for exchangingresources for goods and services
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.
Further reductions of transaction costs Credit and debit cards ATM’s The Internet Direct deposit Posting menus outside restaurants
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?
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.
....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.