Segment 2: Value and Trade

 

 

2.1 Introduction

 

 

Background

 

At the core of economics is the notion that there are valuable gains from trades between individuals and between firms, and between firms and individuals. Value is created when the exchange of goods and services brings more in total to each party than each would obtain if the exchange did not take place. However, to facilitate trade, an appropriate price must be negotiated so that each party benefits from trade relative to their alternative opportunities.

 

To work out whether value can be created between a buyer and a seller, the buyer’s willingness-to-pay for a product is compared with the seller’s willingness-to-sell. These calculations rely on an appropriate economic formulation of the choices facing each party, which depends upon each party’s other trading opportunities. This establishes a clear relationship between potential competition and what each party actually receives from trade.

 

Having established that there is a value-creating trading opportunity, the next key issue is the terms of that trade. In particular, what price should the buyer and seller agree on? This price depends both on the value created and on what would occur if trade did not take place.

 

Textbook Readings

 

Suggested readings include chapters 1-5 of Brandenberger and Nalebuff (1996).

 

Segment Overview

 

·         Topic 2.2 explores the willingness-to-pay and willingness-to-sell determinants of value in considerable depth. It introduces concepts of economic and accounting profit, best alternative options and decision trees.

 

·         Topic 2.3 places the concepts of willingness-to-pay and willingness-to-sell within a trading context.

 

·         Topic 2.4 uses this trading context to describe how parties divide value based on the concept of added value.

 

·         Topic 2.5 considers the impact and behaviour of a monopoly seller in a negotiations context. Negotiations are a common feature of business-to-business trading relationships. The potential inefficiencies associated with monopoly selling are introduced at this point, cementing further concepts of buyer and seller surplus.

 

·         This segment concludes with a segment assignment in which you consider what will happen to value created in the music publishing industry if copyright protection is undermined by new advances in information technology.

 

Your Learning Outcomes

 

Upon completing this segment, you should be able to

·         formulate a buyer’s decision and establish willingness-to-pay

·         formulate a seller’s decision and establish willingness-to-sell

·         identify potential gains from trade

·         apply the concept of added value to determine price in business negotiations

·         analyse the impact of monopoly on one side of the market in terms of overall efficiency

 

Sources

 

Portions of this segment draw upon course materials prepared by Geoffrey Heal (Columbia University), Judith Chevalier (University of Chicago) and Joshua Gans (University of Melbourne).

 

Now go on to topic 2.2, “Economic Decision-Making”.