The Magic of Exchange

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The Magic of Exchange

• One persons trash is another persons treasure.

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Petes Bat and Sams Shoes
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Sams Bat and Petes Shoes
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Why does exchange create wealth?

• One persons trash is anothers treasure.
• Peoples evaluation of goods and services are
• subjective and
• different.

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The Principle of Exchange (an application of
benefit/cost analysis)

• People will exchange if they expect to gain more
  than they give up --- if the expected benefit is
  greater than the expected cost.

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Voluntary Exchange No Rip Offs!

• When agreeing to exchange, both parties expect to
  gain
• more than they give up.

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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.
• The gas station owner gained also.

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When it doesnt work

• Lack of information
• Misinformation -- fraud
• Asymmetric information

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Employment asVoluntary Exchange

• Employers must gain
• I hate my job!
• 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?

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Education asVoluntary Exchange

• You are voluntarily exchanging your money and
  your human capital for this class. Why?
• Many high school students dont expect to gain
  from school. How does that affect the nature of
  the exchange?

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Voluntary Exchange Creates Wealth.

• Wealth is the value that people place on their
  assets, both human and non-human.
• After voluntary exchange, both parties should
  place a higher value on their assets than before
  the exchange. They gave up something of less
  value than they gained.
• If only two people voluntarily exchange, wealth
  is created.

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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.

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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 someones gain.
• With transaction cost, your cost is no ones
  gain.

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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

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You provide your human capital to a firm the
firm provides you with money.
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You provide money to the grocer, you get the
goods and services you desire.
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Money is a tool for exchanging resources for
goods and services
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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.

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Further reduction of transaction costs.

• Credit and debit cards
• ATMs
• The Internet
• Direct deposit
• Posting menus outside restaurants

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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 up.
• When people voluntarily exchange, there are no
  ripoffs.

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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.