Understanding the value of trade

I got in to a discussion a little while back with someone who is quite a bit further to the left on the social/political spectrum than I am. The topic was that of trade. The point I was trying to make was that trade benefits everyone, but I made the mistake of phrasing it “trade increases wealth”. Mentioning the term wealth caused an unfortunate turn in the discussion. I found myself trying to bring it back, but instead faced the topic of whether wealth (defined by this person as having more than you need) was bad.

Later I realized that in place of the word wealth I should have instead used “utility”, which is definitely a classic term from Economics. You can think of it as usefulness. So restated, trade increases utility among those who trade.

Here’s an example. We have a Farmer and a Cobbler. For those who are too young to know, a cobbler is someone who makes shoes. Let’s say Farmer grows carrots. Now Farmer can only eat so many carrots and Cobbler can only wear so many pairs of shoes. In other words, they have very low utility (usefulness) for any extra they produce. If we quantify things it might look like this.

Farmer
Pounds of Carrots: 1-5 Utility: 10/lb
Pounds of Carrots: 6-7 Utility: 1/lb
Pounds of Carrots: 8+ Utility: 0/lb

Cobbler
Pairs of Shoes: 1-5 Utility: 10/pr
Pairs of Shoes: 6-7 Utility: 1/pr
Pairs of Shoes: 8+ Utility: 0/pr

Let’s assume that the Farmer produces 6 pounds of carrots and the Cobbler makes 6 pairs of shoes. If you add up the figures, each ends up with a total utility score of 51 (5 x 10 + 1 x 1 = 51).

Now if we assume that Farmer and Cobbler have the same utility values for each other’s products (1 pair of shoes has a utility of 10 for Farmer and 1 pound of carrot has a utility of 10 for Cobbler) we can see how each benefits through trade. Look at what happens when Farmer gives Cobbler a pound of carrots in exchange for a pair of shoes.

Farmer: 5 lbs of Carrots + 1 pair of Shoes = 60 utility (5 x 10 + 1 x 10)

Cobbler: 5 pairs of Shoes + 1 lb of Carrots = 60 utility (5 x 10 + 1 x 10)

Notice how both Farmer and Cobbler now have a higher total utility than they had before the trade.

Trade is all about increasing utility among the parties involved. The Farmer/Cobbler example is obviously very simple. Even so, it makes the point.

Most trade these days has money on one side of the transaction. Money itself has little or no utility. After all, the electronic balance in your checking account isn’t something you can eat or wear. It does, though, represent the ability to acquire utility by exchanging it for things like food or clothing. Certainly, that adds a layer of complexity to trade in that the value of a currency is subject to change (which is why inflation is such a scary thing), but it helps to facilitate a level of trade that would not be possible otherwise.

International trade may be complicated by political issues, but the same basic idea as the Farmer/Cobbler example applies. Countries specialize in similar, if broader, ways as people. Some have access to physical resources like oil. Others have ample labor forces. They exchange what they have in surplus with each other and thereby improve everyone’s situation. That is why free trade is such a key part of global economic health and why protectionist and isolationist policies can be significant hindrances to that.