Chapter 7 Exchange

1. Chapter 7 Exchange

2. Contents: • The Theorem of Exchange under Zero Transaction Cost • The Model of Exchange without Production under Zero Transaction Cost • Benefits from Exchange • Hindrance to Exchange – Transaction Costs

3. The Theorem of Exchange under Zero Transaction Cost

4. Assumptions: • Private property rights are clearly defined. • Transaction costs are negligible.

5. Reason for exchange: (necessary condition) • There existsa difference in marginal use values.

6. Process: Low • Low/High MUV individuals will sell the good to low/high MUV individuals. high Equilibrium: • Exchange will continue until MUVs / AUVs / TUVs of all individuals are equal. MUVs

7. Result: • Voluntary exchange is beneficial to all participants.

8. Q7.1:Are theft and donation examples of exchange? Explain. Q7.2:Take the exchange of sparkle cards or stamps as an example to illustrate the theorem of exchange.

9. The Model of Exchange without Production under Zero Transaction Cost

10. The model Initial situation: • 2 individuals: A & B • A owns XA0 & B owns XB0 • Their MUVs are different. $ $ Individual B Individual A MUVA MUVB 0B 0A X X XB0 XA0

11. $ $ MUVA MUVB 0B 0A b c XA0 XB0 XA1 XB1 Process of exchange: At H: MUVA* = MUVB* • At b, MUVA > MUVB. Exchange is possible • Exchange will continue until point H is reached where MUVA* = MUVB* • Ms B (low MUV) will sell some of the good to Mr A (high MUV). Initial allocation of goods Final allocation of goods

12. Gain of A (Buyer’s surplus or consumer’s surplus) $ $ MUVA MUVB P=MUVA*=MUVB* Gain of B (Seller’s surplus or producer’s surplus) 0B 0A b c XA1 XB1 Gains from exchange:

13. $ Supply curve of B P* Demand curve of A 0 X* X Market transaction: • Equilibrium price (P*) and quantity transacted (X*) are determined by Mr A’s demand curve (a portion of his MUV curve) and Ms B’s supply curve(her inverted MUV curve)

14. An alternative illustration: A’s gain from exchange $ S $ $ B’s gain from exchange P* P* P* MUVA MUVB MUV X 0 X 0 0 XA0 XA1 XB1 XB0 X X=XA0 + XB0 Amount brought from B Amount sold to A

15. Q7.3:If MUV curves of two individuals are identical, can mutually beneficial exchange occur between them? Explain.

16. Benefits from Exchange

17. Increase in total output through the reallocation of production • Through the reallocation of production, from low/high MC producers to low/high MC producers high low • more output is produced.

18. Increase in total use value through the reallocation of consumption • Through the reallocation of consumption, from low/high MUV consumers to low/high MUV consumers low high • TUV of the goods produced increases

19. Hindrance to Exchange Transaction Costs

20. Transaction costs (TC) • Transaction costs(交易費用) are all those costs that cannot be conceived to exist in a Robinson Crusoe economy. or a one-man

21. Institutional costs • Cost of defining and enforcing property rights • Cost of acquiring information • Cost of determining price and forming other details of the contract • Cost of enforcing contract Examples of transaction costs:

22. $ SB Total gain from trade Gain of buyer P* Gain of seller DA 0 X X* Exchange with transaction costs: • If zero TC is involved in exchange Trade continues until MUVs are equal (where D meets S).

23. $ SB’ SB Buyer’s gain TC Pb’ Ps’ Seller’s gain DA 0 X X* X’ • If a positive per unit TC is involved in exchange (borne by the seller) The per unit TC shifts the supply curve upwards. Trade ceases where the difference in MUVs can just cover the TC. • Qt drops and both buyer’s gain and seller’s gain decrease.

24. Q7.4(a) If the per unit transaction cost iswholly borne by the buyer, will the prediction change? (b) If the per unit transaction cost isshared equally between the buyer and the seller, will the prediction change?

25. Means to reduce transaction costs: • Money In a monetary exchange • The act of sale & the act of purchase are separated • Double coincidence of wants is no longer required • Hence transaction costs are greatly reduced and the volume of monetary exchange increases greatly.

26. Means to reduce transaction costs: • Middlemen - Being specialists or experts, middlemen have more information and are more skilful in bargaining, negotiating and enforcing contracts. Hence they can greatly reduce the costs involved in transactions. - Being middlemen, they greatly reduce the number of transactions.

27. Reduction in transaction costs due to the presence of money and middlemen SB’ $ SB’’ Initial TC Pb’ SB Pb’’ Additional gains from trade Ps’’ Ps’ DA 0 X X’’ X’ Volume of trade increases Exchange with money and middlemen:

28. Correcting Misconceptions: 1. For an exchange between two individuals to take place, each individual must have a surplus in one good and a shortage in another good. 2. If the MUV curves of two individuals are identical, there cannot be mutually beneficial trade between them.

29. Correcting Misconceptions: 3. Exchange will occur if MUVs are not the same across individuals. 4. If the transaction cost of an exchange is borne wholly by one of the two trading parties, that party will gain less from exchange while the other party will gain more.