Lecture 3: Free Markets, Voluntary Exchange, and Money

Transcription

1 Lecture 3: Free Markets, Voluntary Exchange, and Money EC101 DD & EE / Manove Market System>Money p 1 Economics Systems Different cultures have different economic systems with different rules or codes of behavior. EC101 DD & EE / Manove Economic Concepts>Economic Systems p 2

2 In some places, the entire economy works like the army: orders are passed down from the top. In other places, the economy is completely decentralized: families run their own businesses any way they want. Some standard examples of economic systems are: Feudalism and Serfdom The Command Economy ( the former Soviet Union) Free Market System But many other economic systems have been described. [Read about the Incas (A) in the course Schedule.] EC101 DD & EE / Manove Economic Concepts>Economic Systems p 3 Basic Economic Choices As a group, economic agents must make a number of important economic choices: What to produce How to produce it Production decisions Who gets the outputs Who provides the inputs Distribution decisions In different economic systems, these decisions are made in different ways. EC101 DD & EE / Manove Economic Concepts>Economic Choices p 4

3 Free-Market System In the free-market economic system, most economic activity is voluntary induced by economic incentives. Production voluntary activity of private firms. Distribution voluntary exchange EC101 DD & EE / Manove Free-Market System p 5 Example: Shanu s Pizza Palace Shanu opens a pizza restaurant (voluntary production). She leases space, buys ovens (voluntary exchange). She hires workers at $12/hour (voluntary exchange). They produce pizza (voluntary production). Shanu sells pizza to customers (voluntary exchange). EC101 DD & EE / Manove Free-Market System>Example p 6

4 Real Free-Market Economies Most countries, even countries with communist governments, now have free-market economies. They rely mainly on the voluntary economic activities of households and private firms. But real free-market economies also include involuntary private exchange and production government production, induced by a combination of political and economic incentives EC101 DD & EE / Manove Free-Market System>EC101 p 7 Involuntary Economic Activities Example: Shanu s Pizza Palace (again) Shanu must pay taxes to the local government, but she receives police protection (involuntary exchange). The local health authorities require her to keep her restaurant kitchen very clean (involuntary production). She must not allow smoking in her restaurant (involuntary restriction on exchange). EC101 DD & EE / Manove Free-Market System>Deviations p 8

5 Example: Even in the US, governments operate many firms. universities schools hospitals the post office transportation companies transportation infrastructure public services the military Government Production EC101 DD & EE / Manove Free-Market System>Countries p 9 EC101 DD & EE / Manove Clicker Question p 10

6 The Free-Market System and EC 101 Real free-market economies are difficult to analyze. So in EC101 we spend a lot of time on the free-market model. In the model, all economic activities are private and voluntary (arising from economic incentives). The model may help us understand the real world. But the results of the model aren t always realistic. EC101 DD & EE / Manove Free-Market System>EC101 p 11 Voluntary Exchange Voluntary exchange is usually used in freemarket economies to distribute outputs and inputs. Households, firms and governments sell and buy (exchange) goods and services. Voluntary exchange usually increases the welfare of both parties, or, at least, doesn t normally decrease it, because people don t tend to do things voluntarily that make them worse off. Most voluntary exchange takes place in markets. EC101 DD & EE / Manove Market System>Voluntary Exchange p 12

7 Markets Markets are meeting places for voluntary exchange. Traditional markets Supermarkets NASDAQ: a virtual meeting place EC101 DD & EE / Manove Market System>Voluntary Exchange>Markets p 13 Some markets are diffuse and exist in many places simultaneously. market for petroleum (one market worldwide) US labor market (one market or many?) EC101 DD & EE / Manove Market System>Voluntary Exchange>Markets p 14

8 Voluntary Exchange Examples Example 1: You have but prefer I have but prefer Outcome: EC101 DD & EE / Manove Market System>Voluntary Exchange>Examples p 15 Example 2: You have and prefer I have and prefer Outcome: EC101 DD & EE / Manove Market System>Voluntary Exchange>Examples p 16

9 Example 3: You have and prefer I have and prefer Outcome: EC101 DD & EE / Manove Market System>Voluntary Exchange>Examples p 17 Example 4: You have and prefer I have and prefer Outcome: EC101 DD & EE / Manove Market System>Voluntary Exchange>Examples p 18

10 Voluntary Exchange: Moral Voluntary exchange tends to make agents better off, because it is voluntary. It never makes agents worse off (well, almost never). Important exceptions: temptation poor information ignorance EC101 DD & EE / Manove Market System>Voluntary Exchange>Moral p 19 Voluntary Exchange and Trust In most markets, the seller has a lot more information about the product or service than the buyer has. There are laws that protect the unsuspecting from the unscrupulous. But voluntary exchange always requires trust, a form of social capital. EC101 DD & EE / Manove Market System>Voluntary Exchange>Moral p 20

11 Voluntary-Exchange Mechanisms Voluntary exchange is a fundamental aspect of the free market system. But how is voluntary exchange conducted? Two primary mechanisms: Barter Selling and Buying EC101 DD & EE / Manove Market System>Money p 21 Exchange Mechanisms: Barter Accomplished in one step Direct Exchange: you have oranges and want to exchange them for apples. Double Coincidence of Wants. You must find a market with people who have what you want and want what you have. EC101 DD & EE / Manove Market System>Voluntary Exchange>Barter p 22

12 Exchange Mechanisms: Selling & Buying Two steps (rather than one) Selling what you have (getting money). Buying what you want (giving up the money). EC101 DD & EE / Manove Market System>Voluntary Exchange>Selling&Buying p 23 Selling and Buying requires two steps and a special tool (money). But searching for the right market is easier. When you sell, you must find a market with people who want what you have, but they don t have to have what you want. When you buy, you must find a market with people who have what you want, but they don t have to want what you have. EC101 DD & EE / Manove Market System>Voluntary Exchange>Selling&Buying p 24

13 Advantages of Selling and Buying Being able to find the right market easily is very important in complex economies with millions of goods and services. That s why barter is uncommon in advanced economic systems. EC101 DD & EE / Manove Market System>Voluntary Exchange>Selling&Buying p 25 Money Barter requires no special tools, But selling and buying require a medium of exchange: Money Selling means obtaining money in exchange for goods. Buying means obtaining goods in exchange for money. EC101 DD & EE / Manove Market System>Money p 26

14 Commodity money Salt Gold Types of Money Fiat money declared to be money by the state or other institution often exists only as paper (currency), or as intangible notations in computer memory banks (checkable deposits). Fiat money has no value of its own. EC101 DD & EE / Manove Market System>Money>Types of Money p 27 Acceptance of Money Why do people accept paper money in return for valuable goods and services? We accept paper money from others, because we know that others will accept it from us. We can then use the money to buy what we want. The role of legal tender? Bitcoin? EC101 DD & EE / Manove Market System>Acceptance of Money p 28

15 What would happen if I told you Don t accept US dollars they re worthless. But suppose President Trump goes on television and says Don t accept US dollars they re worthless. What would happen then? EC101 DD & EE / Manove Market System>Acceptance of Money p 29 EC101 DD & EE / Manove Clicker Question p 30

16 End of File EC101 DD & EE / Manove End of File p 31