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CAS EC 101 (203)

Markets and Demand.docx

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Boston University
CAS EC 101
Michael Manove

Money  Barter requires no special tools,...  But selling and buying require a medium of exchange: Money o Selling means obtaining money in exchange for goods. o Buying means obtaining a good in exchange for money. Types of Money  Commodity money o Salt o Gold  Fiat money o has no value of its own o declared to be money by the state or other institution o often exists only as paper (currency),... o or as intangible notations in computer memory banks (most US dollars). Acceptance of Money  Why do people accept paper money in return for valuable goods and services? o We accept paper money from others, because... o Bitcoin ?  What would happen if I told you... “Don’t accept US dollars—they’re worthless.” Competition  Competition is the driving force of any free- market economic system.  The analysis of competition will occupy a major part of this course.  Our analysis of competition will focus on selling and buying rather than on barter.  And a very important feature of selling and buying is the determination of prices. Prices  Prices are defined when money is used for selling and buying.  The price of a good is the amount of money exchanged for one unit of the good.  Prices are useful, because they measure the value that markets place on a good.  Prices tell people how much a good is worth! Prices Under Barter?  Prices are not clearly defined in a barter system.  Barter does define an exchange ratio for each pair of goods.  Example: Perfect Competition  The phrase “perfect competition” describes a market with many buyers and many sellers (and other properties).  A perfectly-competitive market represents an extreme case that doesn’t exist in the real world...  ...except in the form of a model.  But some real markets are close to the model.  We will spend a lot of time analyzing the model of perfect competition,...  ...and we’ll say what happens when real markets deviate from the model. Markets with Perfect Competition: Model Characteristics  One homogeneous good   Many buyers and sellers   Voluntary exchange   Full information and perfect foresight   Rational and self-interested agents   Free entry to the market [used later in the course] “Law” of One Price  At any given time in a perfectly competitive market, identical goods must have the same price.  The law must be true, because the opposite is not possible. We show: Under perfect competition, transactions at two or more prices will not be completed.  So suppose two transactions are in progress at two different prices.  What would happen? Why One Price?  The losers know who they are before they make the exchange (full information).  They want to do better (rational self-interest).  The losers decide to trade with each other.  At the compromise price, both would be better off.  The original proposed exchanges (at two different prices) cannot go through! Arbitrage  Suppose o Claudia is ready to buy from Dilip for $1, and... o Randy is ready to buy from Stefania for $3. o And suppose that neither Dilip nor Randy knows that he is a “loser.”  Then Alberto (a shrewd businessman) could o offer to buy from Dilip for $1.50,... o and sell to Randy for $2.50. o Dilip and Randy would be happy,... o and Alberto would earn a tidy profit of $1.  Alberto is an “arbitrageur.”  He takes advantage of price differences in the same product to “buy low and sell high.”
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