1. The Magic of Exchange
SUBJECTIVELY: where one
person’s (perceived) trash is another
person’s (perceived) treasure.

2. Pete’s Bat and Sam’s Shoes
 Would you consider
exchanging these items?

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. The Principle of Exchange
as an application of the
benefit versus cost analysis
People will exchange if they expect to gain more
than they give up --- specifically, if they believe the
expected benefit is greater than their expected cost.

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. 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. 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. 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. 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. 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. 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. 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. 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. You provide your human
capital to a firm and the firm
provides you with money.

15. You provide money to the
grocer and you get the goods
and services you desire.

16. Money is a tool for exchanging
resources for goods and services

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. Further reductions of
transaction costs
 Credit and debit cards
 ATM’s
 The Internet
 Direct deposit
 Posting menus outside restaurants

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. 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. ....DEFINITIONS….
Asymmetric Information Problem: A problem arising
when either buyers or sellers have important action about
the product not possessed by the other side in potential
transactions.
Deadweight Loss: A net loss associated with the forgoing
of an economic action. The loss does not lead to an
offsetting gain for other participants. It thus reflects
economic inefficiency.