Armchair Economics - Mutually Beneficial Voluntary Transactions in a Free Market Economy

My last post outlined the cause of the current financial crisis. This post has more of a conceptual subject, if you will, while it maintains very realistic application. If you've taken any sort of economics course, you've probably heard the phrase mutually beneficial voluntary transactions. As I will continue to say, however, you don't need a degree in economics to understand what they are. Essentially they are the foundation of a free market economy. They are what makes the world go 'round. As usual, I will let a concrete example do most of the explaining. Through the years, I have found that generally this is the easiest way to understand the basic principles of economics.

Ok, so let's say I go to the grocery store and buy a gallon of milk for $4 (I actually bought 2 gallons yesterday). I don't know the exact market price of milk, and I'm sure the demand curve is not likely to shift drastically anytime soon, so I rounded to an even $4. When I check out at the register, putting tax aside, I hand the cashier $4, and take my gallon of milk with me. Now, why did the transaction take place? Simply put, I valued the gallon of milk more than the $4 while the cashier or the grocery store itself values my $4 more than the gallon of milk. Each party stands to gain something from the transaction, thus it is considered mutually beneficial. This concept explains why there are always two thank you's exchanged at the register. A slightly less obvious but equally important idea here is that all of these types of transactions are voluntary, meaning each party actively engages in it and it is not forced. These concepts are the definition of a free market economy in which transactions are not forced. Obviously one of the largest, most meaningful examples of a mutually beneficial voluntary transaction is international trade in regards to imports and exports.

The last thing I want to touch on in this short post is the determinant factor of the number of transactions that take place in any particular free market economy. That factor is price. Let's assume that on any given day at any given grocery store, the price of of a gallon of milk is $5. At this price, 20 people are still willing to buy the milk. As price increases, quantity supplied increases, so the grocery store, wanting to increase their profit, produces 40 gallons of milk. Since the demand for milk at the price of $5 is only 20 people, however, only 20 transactions will take place. This situation is known as a surplus, because quantity supplied is greater than quantity demanded. Remember that these are mutually beneficial voluntary transactions. On the other hand, if the grocery store for some reason lowered the price to $3 per gallon, more people would be willing to buy milk at that price (we'll say 40 people) but the grocery store would lower the quantity supplied to 20, so only 20 transactions would take place. This situation is called a shortage in that quantity supplied is less than quantity demanded. Thus the maximum number of transactions occurs at a price of $3, called the equilibrium price.

Congratulations, you now have a better understanding of mutually beneficial voluntary transactions than politicians and the United States government...


Best,
Tyler