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Economics of Trade

Learn About This Lesson

Learning Objectives

After completing this lesson, you will be able to:

  • Appreciate that trade creates wealth as goods and services are exchanged from one person to another. People buy or trade goods only when the value to them of what they receive is higher than the value of what the pay or trade is to get it.
  • Identify middlemen and the value they provide by facilitating trade. (Farmers and manufacturers are busy farming and manufacturing, so other firms specialize in connecting farm and factory goods with retailers and consumers).
  • Investigate headlines related to ongoing trade disputes. Stories that focus on local companies hurt by international trade may miss that local consumers benefit from lower prices. (And local manufacturers may also benefit from lower-cost imported steel, aluminum, and other raw materials).
  • Explain the relevance of Adam Smith’s famous observation “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices” to trade disputes.

Inquire: I’ll Just Do It Myself

Overview

“It will be easier if I just do it myself.” How often have you said this, or something almost exactly like it? Maybe it will take you less time, but when you’re deciding what to do, it’s important to count all the costs, including what else you could be doing with your time, talent, and treasure.

DecorativeIf, getting dressed one morning, there’s a hole in your sock, do you try sewing it yourself (called darning), or just toss it, wear other socks, and buy new socks later? It takes time, knowhow, plus needle and thread to darn a sock. WikiHow and YouTube videos can help to explain, but they take time to watch. How much is your time worth, and how would you prefer to be spending it? The do-it-yourself repair route, or even the time it takes to learn to darn socks, trades off with just buying new socks on the next shopping trip, or ordering a pair on Amazon.  Today’s clothes are inexpensive. Through international trade, clothes are now shipped and flown to America from around the world.  When you opt to purchase instead of darn your socks, they come from places like “Sock City” – an obscure Chinese settlement in eastern Zhejiang province.1

Sources:
Sock City’s decline may reveal an unravelling in China’s economy,” The Guardian, September 8, 2912]

Big Question

Does international trade benefit producers and consumers in countries other than America as well as it benefits Americans?

Watch: Trade is Voluntary Cooperation
Read: Trade Creates Prosperity

Introduction

DecorativeMost people in developed countries enjoy a standard of living that would surprise their grandparents and shock earlier generations. They consume a wide variety of food and drink — orange juice, fresh fruit and vegetables, in winter for example — not available out-of-season to even the wealthiest a century ago. Few know how to farm or how grain is turned to flour and then bread. Our closets are often overfull of clothes, but we know little about growing cotton or wool or how to turn them into cloth and clothes. From electricity to cars to smartphones, LEDs, solar panels, and medicines, our lives rely on hundreds of technologies we don’t comprehend.

People are more prosperous when they have more of what they want rather than less. When it comes to goods like food and shelter, and services like tax preparation and haircuts, we can either produce them ourselves or trade for them. If we had to produce all of our own things, life would be, as Thomas Hobbes put it, “Solitary, poor, nasty, brutish, and short.” Trading enables us to get more of what we want with less effort. But, that’s not all. Trade also helps us make use of others’ knowledge about things we may not understand.

Our prosperity and our daily lives depend on goods and services from people and firms around the country and the world. Somehow, this knowledge disbursed widely across the world is mobilized and coordinated to produce goods and services shipped to stores nearby, or now dropped at our front doors. These flows of goods and services improve our lives and those of our families, friends, and neighbors. Right now, across the country and around the world, thousands are working on goods and services that we will purchase and enjoy over the coming year. How is that even possible?

Have you ever heard someone say the whole is greater than the sum of its parts? They mean that when two people get together, they can accomplish more than the sum of what they could accomplish were they working alone. People write and speak this way about different human configurations like corporations, church groups, nonprofits, entire societies, and football teams. The slogan gets to the heart of what we mean when we analyze the effects of specialization and trade. With a few simple examples, we can see how cooperation through specialization and trade gives us more goods and services, more time, more resources, or some combination of all of these.

Imagine that an inventor goes on the news and says, “I have a great idea, an amazing invention. It’s a factory that turns corn into cars.” Sure enough, when he shows people his factory, corn comes in, and cars come out. Everybody thinks this is the most amazing thing, because we’re able to send corn that we grow in the United States into this factory and get cheaper cars than we have enjoyed before.  Everybody lauds the inventor. They think he’s a great guy and a true benefactor of humanity. But, a journalist investigates the factory and discovers that what they’re doing is taking the corn, loading it on boats, shipping it to Japan, and shipping cars from Japan back to the United States, and running them out of the factory.

This classic example in economics is known as the Iowa Car Crop example. We would expect people to be horrified by the inventor lying about his invention; pretending that he invented something when in fact he was facilitating international trade. Rather than dumping the corn into a machine – out of which would pop cars – he’s putting the corn on boats, shipping it to Japan, and shipping cars back. Yet, this is fundamentally no different from inventing a machine that literally turns corn into cars.

DecorativeTrade is a technology. Trade is one way we can turn corn into cars: just the same way a machine that turns corn into cars would also be a technology. By trading, we take advantage of division of labor and specialization to lower the cost of producing cars, as well as corn, and we’re able to have more of both at lower prices.

Trade creates wealth, even between countries, and even between countries with enormously different production possibilities. Worries about competition from low-wage workers in low-wage countries may well be misplaced. As the economist Paul Krugman has pointed out, if people in poor countries attain Western levels of productivity, they will earn Western incomes. Contrary to popular belief, there’s no race to the bottom in wages and working conditions. Trade, per se, makes us better off by making us more productive.  When low income countries adopt more market-oriented institutions, we should expect to see them increase productivity considerably.

Many criticize international trade, noting that the lower-cost goods shipped from China and other countries, though eagerly purchased by American consumers, can cost the jobs of American workers. A CNN Money article reported on a study deeply critical of goods imported from China. Such concerns have merit. When we purchase wine or beer or cheese from other states or another country, we usually had the opportunity to purchase similar goods produced in our community, state, or country and chose not to. How do we balance the ethics and economics of purchasing some goods and not others?

Though trade creates wealth, it can create disruption as well. Some local companies may struggle, competing with goods imported from other states or countries. Other local companies may find their goods and services in huge demand around the world. Trade also creates unbalanced news stories. When a local factory closes and hundreds are laid-off, it is big news, and many call for political responses. But, when hundreds of consumers save money shopping thanks to lower priced imported clothes and they spend their savings at other local merchants, it’s not news, even though more jobs may be created.

Special Guest Lecture by Professor Art Carden

Reflect: Gains from Trade and Limits to Local

Poll

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Expand: Why Do We Have Middlemen?

Why do we have middlemen? There are few people so wildly and roundly despised as the middleman, or the person who coordinates buyers and sellers. On the surface, it looks like the middleman, or the merchant, is taking a cut without adding any value, but this is incorrect. How does a middleman like a distributor or retailer, or even a ticket scalper, add value? Exchange turns trash into treasure by getting goods into the hands of those who value them most. Adam gives up his baseball ticket to get David’s opera ticket. David gives up his opera ticket to get Adam’s baseball ticket. Wealth is created because they each get something they prefer to what they give up.

DecorativeBut, things aren’t always that easy. If you have a baseball ticket and you want an opera ticket, it might be hard to find someone who has the opera ticket you want and wants the baseball ticket you have. Enter the middleman, or in this case, a ticket broker. The broker finds people who want to buy opera or baseball tickets and people who want to sell them. Adam might be able to get a better bargain for his baseball ticket if he were to hold out and search for someone with an opera ticket, but that would consume time and energy he might prefer to use for other things.

What’s the scalper’s value added? He relieves Adam and David of the burden of finding someone to buy their tickets on mutually agreeable terms. For the tickets they want to buy, he relieves them of the burden of searching for people who have the tickets they want. The scalper doesn’t create any new physical output, or any new operas or baseball games, but he does provide Adam and David with convenience.

The ticket broker may not care about opera or baseball, but he values opera and baseball tickets because he knows other people do. Retailers basically do the same thing. If you really wanted to, you could drive to each individual factory or farm to pick up your weekly groceries, or you could contact every company you patronize and have them ship their wares directly to your door. This would be extremely costly, however. It’s far easier to go to a supermarket or order from an online retailer like Amazon. While these intermediaries don’t produce any physical output, they add value by providing convenience. A retailer might not like soft drinks, but he will be willing to stock them because he knows people do.

Wouldn’t it be nice if you were able to walk right up to the gate and get a cheap ticket to the concert? Wouldn’t it be nice if stores didn’t mark up the wares on their shelves? Of course it would. We don’t like paying for things. The opportunity to earn a profit, however, is what motivates the ticket scalper to take the risk that comes with having a fistful of tickets to the big concert and what motivates the shopkeeper to have well-stocked shelves when he could be doing something else.

Toolbox

The Truth About Trade: What Critics Get Wrong About the Global Economy”

Economist Doug Irwin’s foreign affairs article against the EPI and similar claims from Foreign Affairs (July/August, 2016).  The 2016 election campaign’s “anti-trade rhetoric paints a grossly distorted picture of trade’s role in the U.S. economy. Trade still benefits the United States enormously, and striking back at other countries by imposing new barriers or ripping up existing agreements would be self-destructive. The badmouthing of trade agreements has even jeopardized the ratification of the TPP in Congress. Backing out of that deal would signal a major U.S. retreat from Asia and mark a historic error.”

“Don’t Hector the Farmers and Don’t Wrap the Veggies”

Economist Gregory Rehmke from Economic Thinking on the wider the network of trading opportunities, the more opportunities for gain from producing goods and services as well as purchasing. The German company Metro (similar to Costco in the U.S.) has expanded around the world. When they opened a new store in Vietnam, local consumers could purchase a wider range of goods imported from around the world. Also, local Vietnamese producers worked with Metro so their produce was sold not only in the local store, but exported and sold in Metro stores in other countries.

Glossary

AJAX progress indicator
  • Imports and exports
    People and firms in the U.S. export goods and services to other countries, and import goods from people and firms in other countries.
  • International trade
    Exchange of goods or services between people or firms in different countries.
  • Opportunity Cost
    Every choice has a cost measured by what’s given up. Each good we purchase has a cost separate from the money cost. Opportunity cost is what now can’t be purchased because of what we did buy. Going to a movie, we give up the next valued good we could have purchased with the ticket money, and(...)
  • Voluntary exchange
    Trading one good or service for another, or for money without force or fraud

License and Citations

Content License:

Lesson Content:

Authored and curated by Art Carden Ph.D. and Gregory F. Rehmke M.A. for The TEL Library.  CC BY NC SA

Media Sources:

 LinkAuthorPublisherLicense
DecorativeJunk Shop Clutter Antique Vintage Shop Second HandMrsBrownPixabayCC 0
DecorativeSocks Fashion Clothing Color Motley Checked GreenCrepessuzettePixabayCC 0
DecorativeDock with containers freestocks.orgPexelsCC 0
DecorativeBackground Concert Ticket StubsPublicDomainPicturesPublic Domain Pictures.net CC 0