Lecture 3: Free Markets, Voluntary Exchange, and Money

Lecture 3: Free Markets, Voluntary Exchange,

and Money

EC101 DD & EE / Manove Market System>Money

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EC101 DD & EE / Manove Clicker Question

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Economics Systems

Different cultures have different economic systems...

with different rules or codes of behavior.

EC101 DD & EE / Manove Economic Concepts>Economic Systems

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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 are:

Feudalism and Serfdom The Command Economy Free Market System

But many other economic systems have been described. [Read about the Incas in LaunchPad or the course

website.]

EC101 DD & EE / Manove Economic Concepts>Economic Systems

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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

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Free-Market System

In the free-market economic system, most economic activity is voluntary-- stimulated by economic incentives.

Production

voluntary activity of private firms.

Distribution

voluntary exchange

EC101 DD & EE / Manove Free-Market System

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Example: Shanu's Pizza Palace

Shanu opens a pizza restaurant.

She leases space, buys ovens.

She hires workers at $12/hour.

They produce pizza.

Shanu sells pizza to customers.

EC101 DD & EE / Manove Free-Market System>Example

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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 political rather

than economic incentives

EC101 DD & EE / Manove Free-Market System>EC101

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Involuntary Economic Activities

Example: Shanu's Pizza Palace (again)

Shanu must pay taxes to the local government, but she receives police protection.

The local health authorities require her to keep her restaurant kitchen very clean.

She must not allow smoking in her restaurant.

EC101 DD & EE / Manove Free-Market System>Deviations

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Government Production

Example: Even in the US, governments operate many firms.

universities schools hospitals the post office other examples ....

EC101 DD & EE / Manove Free-Market System>Countries

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EC101 DD & EE / Manove Clicker Question

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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 freemarket 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

accurate.

EC101 DD & EE / Manove Free-Market System>EC101

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Voluntary Exchange

In free-market economies, voluntary exchange is usually used to distribute outputs and inputs.

Households, firms and governments sell and buy, (exchange), goods and services.

Voluntary exchange normally increases welfare of both parties...

...or, at least, doesn't decrease it.

Most voluntary exchange takes place in markets.

EC101 DD & EE / Manove Market System>Voluntary Exchange

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Markets

Markets are "meeting places" for voluntary exchange

Traditional markets

Supermarkets

NASDAQ

EC101 DD & EE / Manove Market System>Voluntary Exchange>Markets

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Some markets are diffuse and exist in many places simultaneously.

market for petroleum

US labor market

EC101 DD & EE / Manove Market System>Voluntary Exchange>Markets

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Voluntary Exchange Examples

Example 1: You have

but prefer

I have

but prefer

Outcome:

EC101 DD & EE / Manove Market System>Voluntary Exchange>Examples

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