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Voluntary Exchange Manove.docx

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Boston University
CAS EC 101
Michael Manove

Voluntary Exchange, Money, and Prices Important Economic Concepts Wealth  Wealth refers to the capacity to create valued goods and services.  Wealth takes many forms: o buildings, roads, machines, ships, cars, stores and warehouses filled with goods; o education and training, which makes people more productive; o good governmental institutions; and o productive social and economic organizations, private and public.  Economists want to understand why some societies have far more wealth than others. Economic Agents  The word “agent” is economic jargon for a person or group that plays an active role in the economy.  We describe three important types of agents. o Households  Individuals living alone, or  Small groups living together (often related) and making joint economic decisions o Firms  Individuals producing alone, or  Groups of people producing together. o Governments  Groups of people who jointly regulate households and firms.  Governments may be viewed as specialized firms with regulatory functions.  Governments also provide public goods, [to be discussed later]. o Households, firms, and governments are  composed of many of the same people,…  playing different roles. Economics Systems  Different cultures have different economic systems  With different rules or codes of behavior.  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: o Feudalism and Serfdom o The Command Economy o Free market System  But many other economic systems have been described. [Read about the Incas on the course website.] Basic Economic Choices  As a group, economic agents must make a number of important economic choices: o What to produce {Production decisions} o How to produce it {Production decisions} o Who gets the outputs {Distribution decisions} o Who provides the inputs {Distribution decisions}  In different economic systems, these decisions are made in different ways. 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  EX: Shanu’s Pizza Palace o Shanu decides to open a pizza restaurant. o She leases space, buys ovens (voluntary exchange). o She hires workers at $12/hour (voluntary exchange). o They produce pizza (voluntary production activity). o Shanu sells pizza to customers (voluntary exchange). Free-Market Model and EC 101  Most countries, even countries with communist governments, now have free-market economies.  In EC101 we spend a lot of time studying the free-market model,  Which is a highly simplified representation of a free-market economy.  In the free-market model, all firms are private and unregulated.  But that isn’t true in real free-market economies, which are sometimes called “mixed” economies.  So we will also study how real economies deviate from the free-market model.  EX: Shanu’s Pizza Palace (again) o Shanu must pay taxes to the local government, but she receives police protection (involuntary exchange). o The local health authorities require her to keep her restaurant kitchen very clean (involuntary production activity). o She must not allow smoking in her
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