"Trade Is Made of Win," Part 1: Wealth Creation

Release Date
March 3, 2011

Topic

Free Markets and Capitalism
Description

How does trading make people better off? Economics professor Art Carden explains in this quick lesson on one of the most important concepts in Economics 101: trade creates wealth. Part 1 of 3.

  • How Ideas Trump Crises  (Video): Alex Tabarrok, in this TED talk, describes how globalization and trade makes everyone better off.
  • Desert Island Game (game, beginner): Can you learn something about trade and cooperation by being marooned on a desert island?
  • Trade Ruler (game, advanced): As the Supreme Ruler of an island, you want the country to prosper. By engaging in international trade, you can achieve this goal.
  • A Petition  [Article]: First published in 1845, Frédéric Bastiat brilliantly demonstrates the absurdity of protectionist arguments.
  • Free Trade  [Article]: Daniel Griswold explains how the benefits derived from the division of labor and comparative advantage extend beyond politically determined boundaries (found on pp. 26-34).
  • Free Trade and the Steel Industry  (Video):Milton Friedman makes the case for free trade at a 1978 lecture at Utah State University.
  • The Iowa Car Crop  [Article]: Steven E. Landsburg makes a compelling case for free trade with a simple thought experiment.
  • Globalization and Trade Deficits  [Audio]: A discussion between Don Boudreaux and EconTalk host Russ Roberts covering comparative advantage, winners and losers from trade, trade deficits, and inequality.
  • Roberts on Smith, Ricardo, and Trade  [Audio]: Russ Roberts discusses how the number of people we trade with determines the incentives for specialization and wealth creation.

Trade Is Made of Win, Part 1: Wealth Creation
One of the most important ideas in all of economics is that trade creates wealth. It’s also one of the least understood ideas in all of economics. Most people think that if two people trade, one of them has to win and one of them has to lose. But one of the ideas that has evolved in economics is that trade creates wealth, and we’re going to see that in the context of a couple of simple examples.
Consider two people, Fritz and Lou. Fritz and Lou can produce two goods. They can produce socks and they can produce corn. In a given year, Fritz could produce 500 socks or 1,000 ears of corn. Lou, on the other hand, could produce 25 socks or only five ears of corn. For Fritz, every sock that he produces costs him the opportunity to produce two ears of corn. Same story for Lou. Lou could produce 25 socks or five ears of corn, so every sock costs him one fifth of an ear of corn. Every ear of corn costs him five socks. Suppose that Lou comes up with an idea: Lou goes to Fritz and says, “Hey, tell you what. How about you specialize in corn and I’ll specialize in socks, and then I’ll trade you one sock for every ear of corn you’re willing to trade me.” What we want to do is compare the price at which they propose trading to their opportunity costs.
If you’re Fritz, every sock costs the opportunity to produce two ears of corn. If Fritz is able to trade for socks, then every sock is only going to cost him one ear of corn. Fritz would prefer the trade. Why? Because socks are now cheaper.
Let’s see what happens to Lou. If Lou is going to produce corn himself, he has to give up five socks in order to produce that corn. If Lou trades for corn, he only has to give up one sock per ear of corn. Fritz, the buyer of socks, is now able to get socks cheaper. Lou, on the other hand, is able to sell his socks for more than he could get them for if he produced them himself. Fritz wins. Fritz is made better off. Lou wins. Lou is made better off. Trade is made of win or, as your economics professor might have told you, trade creates wealth.