Wednesday, May 6, 2009

A example of trade

People often complain that the "rich are getting richer". And yes, this is in fact true. It is very true. (Remember to focus on longer trends. In the last 1 year, the rich have probably gotten quite a bit poorer (as have the rest of us); however, in the last 100 years, the rich have gotten quite a bit richer.) Unfortunately, many people stop their thought process at this simple observation. There seems to be an assumption that "the rich have gotten richer AT THE EXPENSE of the poor". This is quite false. Remember, the economic pie is not baked a fixed size. When I get a bigger piece of the pie, you do not necessary get a smaller piece. Alex Tabarrok explained this quite eloquently in his TED speech. I'm paraphrasing, but Tabarrok recounts a story by Thomas Jefferson talking about having a candle that is lit. And when others come to us needing light, they can dip their candle into ours and they gain light and we are not darkened. Tabarrok has an addendum, though. He says, when others light their candle at ours, there's twice as much light available for everyone (end paraphrasing). So you see, the pie actually gets bigger.

But how can that be? We have the same amount of "stuff" on earth. God didn't come down yesterday and give us an addition 1 billion pounds of ore or gold or air or water because He noticed we were short. Yet somehow, we have more than we did previously. Way more. Way way more! It actually very beautiful how that economic pie gets bigger. First, an abstract example, then a concrete one:

1) You have an Xbox and I have a cure for diabetes. You are happiness neutral. I am happiness neutral. If we were to set up an equation for our economic pie, it would read: 1 Xbox + 1 cure for diabetes + happiness neutrality (0). Let's add to this scenario. I love playing video games, but have no money. You have diabetes but have no money. So, we trade. The new equation would still contain only 1 Xbox and only 1 cure for diabetes, but the happiness coefficient would grow. Not only is there more happiness, but the Xbox now inherently is worth more and (more importantly) so is the diabetes cure. The two of us have rearranged our resources to better fulfill our needs. To each of us, our slice gets bigger.

2) A concrete example: Just last month, my roommate and I were looking to clear up some room in our apartment. We decided to sell his cabinet. Our bottom price was 'come pick it up and you can have it for free'. We didn't advertise this price. We advertised $50. A buyer contacted us, offering the $50. When he came to pick up the cabinet, he had three $20 bills. I had no change. I told him that $40 was fine, don't worry about the difference. As we loaded the cabinet into his car, in a moment of honesty he bluntly said, "ya know, this is a nice cabinet, I would have gladly paid $60 or even $75 for it." Again, let's look at the math. My roommate and I would have gladly given the cabinet away for free. So, we netted an extra $40 utility. This buyer would have gladly paid $75 for the cabinet. His extra netted utility was $35. Both parties were completely justified in thinking the other a sucker. But through this trade, $75 of utility was created (our $40 + his $35).

Watch the Tabarrok TED talk. It's really cool. Remember, when trade isn't coercive and both parties are voluntarily taking part in the exchange, the economic pie gets larger.

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