5.3 Review: Interpersonal exchange

Lecture 5: Interpersonal exchange
  • All economic action involves exchange. An economizing individual acts to exchange one situation for another.
  • In week 3 we discussed how humans trade immediate satisfaction for future satisfaction when foregoing leisure for labor.
  • In week 4, we saw how capital necessitates the trading of present consumption goods for future consumption goods.
  • Both of these trades are ultimately individual trades: The individual trades with their future self.
  • Today we discuss individuals engaging in exchange with other individuals.
  • Economic exchange with others is distinct. It involves another individual acting human, with their own will.
  • There are two ways of dealing with others: Coercion: overriding their will, vs cooperation: respecting their will.
  • When you introduce another individual into life, there is a choice between fighting or cooperating. The reaction could be violent, murder, attack, enslave, or rob.
  • Violence and the threat of violence. The way of animals. Zero sum or negative sum games.
  • Reason, morality, intelligence, and long-term orientation move us from violence to cooperation and voluntary exchange.
  • Society emerges from people able to deal with one another based on consent, cooperation, and the rejection of the initiation of violence.
  • Voluntary exchange benefits both parties. It must because otherwise they wouldn't undertake it. Both parties value the thing they don't own more, and so an exchange benefits them both.
  • The price is not the value. If the value was equal to the price, why would either of them want to trade?
  • Voluntary exchange is another way we can know that value is subjective. Marginal utilities of exchanged goods have to increase for both parties. Each party gains a higher satisfaction from the thing they gain.
  • If value is objective, how could trade happen?
  • Anywhere and anytime humans have been observed, they have traded with each other. Economics isn't an attempt to preach trade, it is an attempt to explain its universal pervasiveness.
  • Difference is enriching as it creates opportunities for trade and specialization


Trade happens because people benefit from it. Why?


1. Differing subjective valuation

  • People will value different things differently, and will find benefit from exchanging them.

2. Absolute advantage:

  • Exchanging things in which you have a lower cost of production for things with a higher cost of production
  • People have differences in their cost of production, and will benefit specializing from producing the goods which they can produce at lower cost, and trading them for other goods.
Example:
  • Person X produces 12 units of A in each hour, or 4 units of B.
  • Person Y produces 6 units of A in each hour, or 18 units of B.
  • If they are producing independently, in an 8-hour working day divided equally between A and B, they would produce:
    • X: 48 A and 16 B
    • Y: 24 A and 72 B.
    • Total: 72 A and 88 B Produced in 16 hours between them
    • If they each specialize in producing only what they produce cheapest, they would instead have:

X: 96 A
Y: 144 B

Total: 96 A and 144 B Produced in 16 hours between themThey can work the same amount of time and produce 24 A and 56 B more! Simply by focusing on producing what they are each most efficient at.

3. Comparative advantage:

  • Even if one person is better at everything, they would benefit from specializing and trading, because they would have a lower opportunity cost.
Example
  • Person X produces 3 units of A in each hour, or 3 units of B.
  • Person Y produces 8 units of A in each hour, or 4 units of B.
If they are producing independently, in an 8-hour working day divided equally between A and B, they would produce:
X: 12 A and 12 B
Y: 32 A and 16 B.

Total: 44 A and 28 B

If they each specialize in producing only what they produce cheapest, they would instead have:
X: 24 B
Y: 64 A
Total: 64 A and 24 B


  • Even when one party is more productive at both, it would still benefit from specializing in what it produces at a lower opportunity cost.
  • People can see these reflected in prices. When people travel from one place to the other they notice the differences in prices. They then sense an opportunity for benefiting by engaging in exchange across the countries.
  • As the difference in price creates an opportunity for trade, production of goods will go more toward the places where it is cheaper. Specialization intensifies and expands as more people trade together in a growing social structure.

4. Specialization and the division of labor

  • Specialization is driven by:
    • Mises: Differences in abilities and differences in nature-given factors
    • Rothbard: (a) differences in suitability and yield of the nature-given factors; (b) differences in given capital and durable consumers' goods; and (c) differences in skill and in the desirability of different types of labor.
    • Nature and individual abilities matter, but as an economy advances technologically and in capital accumulation, theprimary driver of specialization increasingly becomes differences in accumulation of specialized capital.
    • Gains from trade inevitably arise in a capitalist society, as capital accumulation drives comparative advantage. People who have capital for a job will have a lower marginal cost for it.
    • Accumulating capital in any industry leads to higher productivity. On an individual, geographic, or national levels, there will inevitably be differences in types and quantities of capital goods accumulated.
    • People, cities, and countries who own large quantities of shirt-producing machines will be able to produce shirts ata lower cost. Those who own capital for the production of cars will produce plenty of cars, and so on.
    • Without capital accumulation there would be very little scope for specialization and differentiation.

5. Extent of the market

  • The larger the market, the more partners, the more goods, the more the scope for specialization, and the higher the productivity.
  • Only when there are enough people to produce the essentials can other people move to producing new and moresophisticated goods.
  • Our modern high productivity isn't possible without highly complex specialization worldwide. We couldn't specialize so much if we couldn't sell our goods worldwide, and provide for ourselves.
  • Someone out there has spent decades working on car windshield design. He can only do that through delegating to others the production of his present goods, through trade. And he can only do that because his work will be incorporated into many thousands of cars.
  • The larger the area with which a person can trade, the more they can benefit from specialization and the division of labor. The larger the number of people you can trade with, the more there is an opportunity for the accumulation of capital in specialized production.
  • The more people you trade with, the more potential buyers for your good. Also, the more potential sellers to choose from.
  • All of the most prosperous places in the world have large areas with which they trade freely. Examples: USA internally; Hong Kong, Singapore, New Zealand, Switzerland versus North Korea, Venezuela, Cuba, Eritrea South Korea vs North Korea
Last modified: Tuesday, July 27, 2021, 2:02 PM