A transaction is a swap - I swap something that I have and you want for something that you have and I want. There were transactions long before there was economics. In fact transactions are one of the defining features of humanity.
There are three main types of transaction, wealth for wealth (i.e. something with inherent value swapped for something else with inherent value), which is barter - discussed later; wealth for money, which is what we are used to; and money for contracts - again discussed later.
In order for wealth to be traded it must have value. In fact the value of an item of wealth has two forms, use value and exchange value.[40] Use value is the usefulness ('utility' in economic terms) that a good or service provides to a particular person. A particular good or service has different use values for different people. It can't be measured in any absolute sense though it can be expressed in a subjective sense for a particular person as in I would like an ice cream twice as much as a packet of crisps. Usefulness or utility is not restricted to functional use, it incorporates any reason why a thing is wanted, which may be decorative, ego-boosting, or satisfying in some other way, however obscure it may seem to others. Use value is 'real' value[41] - it is the extent to which a thing is wanted. It changes with time and circumstances as novelties wear off and as satisfaction replaces desire - I might really want a meal after not eating all day, but as soon as it's eaten I don't want a meal at all.
Exchange value is what a buyer is willing to pay to the seller for the thing that is traded. In barter societies (if any really existed - there's great doubt that they did, see Graeber 2011, Chapter 2) all bartered goods have exchange values related to all other goods that they are bartered for. Sometimes they are fixed and sometimes they are determined by haggling. In non-barter societies exchange value is expressed as a money price, and is again either fixed or haggled over when a good or service is exchanged for money. Exchange value can vary enormously at different times depending on very many factors such as the value of money, the number of buyers that are aware of the item for sale, the nature of the available buyers and the money that they have, the general state of the economy, the degree of desperation of the buyer or seller, how fashionable the item is, and so on. Exchange value is therefore not a permanent feature of an item; it just reflects its tradable worth relative to other tradable things at a particular point in time.
The value of a good or service can be expressed in two forms: use value is its usefulness to a particular person, and exchange value is what a buyer is willing to pay for it.
An important point to be aware of is that a change in the exchange value of an item is not in isolation a change in the wealth embodied in that item, although it is normally regarded as such because we measure wealth in terms of money. A change in exchange value represents a change in attitude of people who want to buy or sell it, usually because of a change in circumstances. A two-up two-down terraced house remains exactly that regardless of whether its exchange value is £100 or £100,000. The only way the wealth embodied in the house can change is by its inherent nature changing. It would fall if it became dilapidated or the roof blew off, or rise if it was refurbished or extended.
Wealth only changes when its inherent nature changes such as in quality or extent. A change in exchange value doesn't change wealth, but a change in the inherent nature of wealth normally changes its exchange value.
The confusion of exchange value for wealth is deeply embedded. When people hear that £billions have been wiped off share values in a stock market crash many ask where all the money has gone. The answer is that no money was ever there. What has happened is that people's willingness to buy[42] the shares has dropped, sometimes dramatically. The company shares are still just the same as they were before the crash, but now they have much lower exchange values. House owners who find that the value of their house has risen significantly over a short period of time are often tempted to re-mortgage in order to spend the extra 'wealth' that they assume is theirs. Banks are also happy to lend on the basis of increased house values because the collateral is worth more, though this happy situation can easily come badly unstuck when willingness to buy evaporates and house values fall but the debt is still there and still has to be paid off. Taking on a debt on the basis of a recent rise in willingness to buy represents a gamble on that willingness persisting. Companies also often make the same mistake. The only reliable way to turn a short-term increase in willingness to buy into wealth or wealth entitlement is to sell the asset while the willingness persists. Rapid increases in asset values are often bubbles, destined to pop sooner or later, but it is very difficult to recognise a bubble during its formation because there are always plausible reasons - or at least we tell ourselves that there are - for the rise. Asset bubbles are only widely recognised as such after they have burst.
Thinking that money and wealth are the same is harmless enough for an individual person or company, but thinking that a rapid rise in the exchange value of wealth is the same as an increase in wealth is not - relying on its persistence is very risky.
It isn't only individuals and small companies that assume willingness to buy is the same as wealth. Banks and large companies have taken to valuing relevant assets in terms of current market value - termed mark-to-market accounting.[43] This replaced the more traditional historic-cost accounting (where value is based on original cost) in the 1980s. Mark-to-market valuations are very volatile, changing daily with the emotions of speculators, whereas historic-cost valuations are much more stable. Mark-to-market accounting is one method by which banks and corporations justify the very large salaries and bonuses paid to directors and senior managers. After all if a company's share price has risen by 10% in a year why shouldn't those who engineered it get a share of the increase in company value? The problem is that company worth has only grown in terms of willingness to buy, which can evaporate much more quickly than it appeared. When it does the directors and managers keep everything they were paid, because it was paid in hard cash, whereas the growth that it was based on had no real substance at all. In these cases the shareholders suffer both the loss of the cash paid to directors and managers and also the loss in value of the shares. It isn't willingness to buy itself that is the problem, because willingness to buy defines all exchange values, it is rapid changes in willingness to buy that should sound alarm bells. Basing payments and debts on long-standing exchange values is justifiable, but basing them on short-term increases is not.
Although people exchange goods and services for their exchange value, they want them for their use value. This is what usually makes trade a win/win situation. When I buy a loaf of bread from a supermarket I want the bread more than the money I pay for it, otherwise I wouldn't buy it, and the supermarket wants the money more than it wants the bread, otherwise it wouldn't sell it. To me the bread is more useful than the money, and to the supermarket the money is more useful than the bread. Hence both I and the supermarket gain from the transaction. This is what makes trade so beneficial. Everything that is wealth must have a use value, because use value is the reason why it can be traded, but things that have use values don't always have exchange values. For example people spend a great deal of time doing or making things for themselves without their being useful to anyone else. Such things can't be considered wealth because they can't be traded. Note that money has an exchange value but no use value, but money isn't wealth.
In order for a transaction to occur in a free society there must be two parties - a willing buyer and a willing seller.
However, trade is only win/win provided that buyers know what is being bought and how much they are paying for it, and sellers know what is being sold and what they are being paid for it. In economics this is known as information symmetry - both sides have the same information. Where this doesn't apply - known as information asymmetry - the person who lacks information is at a serious disadvantage and is normally exploited by the better informed party. For example the seller of second-hand goods normally has a lot more information than the buyer, unless the buyer is an antique dealer, when they are usually better informed. As will be seen in Part 2 much of the banking and financial trading sector is built on buyers not realising what they are buying, or perhaps more especially not realising what they are paying for the services they get.
Provided that each party has the same information trade makes them both better off than they were before - a win/win situation.
Nevertheless a transaction is a competition between seller and buyer. The seller wants to receive as much as possible for the product and the buyer wants to part with as little as possible. Each seeks to exploit any advantage that they can find or can engineer. Sellers emphasise benefits, buyers emphasise faults. Therefore conflict is built into economics at the most basic level. Fairness doesn't arise naturally because both sides prefer bias. Information is one aspect that can destroy fairness, another is bargaining power. When one party is more willing than the other for the transaction to take place and that fact is known to the other party, then it can and usually will be exploited to their advantage.
In a nutshell this summarises the economic problem. We want to exploit other people but don't want to be exploited by them.
You might think that overstates the situation. We don't really want to exploit other people do we? But when offered a bargain how many of us ask why the price is so low and offer more if it is because the seller is desperate? The more considerate of us might pay the asking price without trying to lower it even more, but many do.
Much of the rest of the book is devoted to the characteristics of this problem - where and how it arises, who wins and who loses, how it is managed, and how things can be improved.
If nothing is done to manage the problem the spoils go to those who are more skilled at exploitation and at the avoidance of being exploited. Competitions create polarisation - winners and losers - and unmanaged transactions are no different.
Since the problem lies at the level of individual participants and on its own it creates polarisation, the solution must lie at a higher level - at the level of society as a whole, and the solution is to impose rules that engender fairness as far as possible. Yet that isn't how the problem is currently managed. Since the early 1980s neoliberal economists have been very successful at persuading governments that the higher level is the market, not society. They argue that markets themselves constrain the ability to exploit, and they do it so successfully that any interference by governments or state institutions only makes things worse. The difficulty here is that in order to constrain exploitation a market must be perfect, which requires perfect competition, and a perfectly competitive market requires a multitude of conditions that are never realised in practice.[44] Nonetheless, neoliberals, while accepting that a perfect market is not achievable, still believe that state interference - even if applied with the best of intentions - will make even an imperfect market worse. It is certainly true that state interference can make things worse, but that is a far cry from assuming that it must always make things worse. Neoliberals therefore discourage rules aimed at promoting fairness and preventing exploitation, and encourage rules that promote ever more freedom for market participants - freedom whose range and effectiveness increase with wealth but shrink without wealth. The result of nearly forty years of this approach is the world we see today. You can judge its success for yourself - my judgement will be evident from this book.