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Saifedean Ammous
Foreign. Principles of Economics. My complete guide to Understanding Economics is now available in hardcover, audiobook and ebook from seifeddin.com, amazon and many more booksellers worldwide. And now I am also teaching a course based on this book on my website seyfeddin.com Principles of Economics will run the whole academic year from September to June and will have a new lecture every two weeks as well as weekly live online discussion seminars open to learners from all over the world and from all walks of life. Whether you're a student, a professional, or a retiree, you are making economic decisions every day and this course will arm you with the wisdom of centuries of economists to improve your economic decision making. You'll also get a free book of Principles of Economics. If you sign up for the course, go to seifedin.com and sign up now. Hello, welcome to Lecture 9 of Principles of Economics online course. Today's lecture's topic is trade. This is the first lecture in the third part of this course, or the first chapter in the third part of the book. If you remember the first part of the book. The first three chapters discussed the foundational concepts and the fundamental ideas on which the Austrian approach to economics is built. The second part of the book discussed economizing, the acts of economizing from an individual perspective. So we looked at the ways in which individuals discuss in which individuals economize in isolation. In this third part, we introduce other people into the equation of economization. How do people economize when they are in dealing with other people, and what social methods of interaction and economization exist? So, to begin with, the basic idea that we need to keep in mind here is that there are only two modes of interaction between people, two ways in which people can interact with each other, consent and coercion. In the process of consensual interaction, everybody agrees on what to do and no violence or threat of violence is employed to get a person to take part in any kind of interaction. On the other hand, when coercion is the mode of interaction between two people, violence or the threat of violence is motivating the actions of one of the two parties. This is a very basic idea to keep in mind, and it is the fundamental principle from which we begin to think about how people interact and economize in a social setting. Trade the topic of this chapter is a prime example of consensual interaction. If both parties engage willingly in trade, we can then deduce that they both expect to benefit from it. Why if two people willingly choose to exchange goods with one another, one person gives one good and the other person gives him another good, we can be sure that both of them expect to benefit. Trade is effectively a positive sum game. Both parties are better off. With coercion, we can deduce one party is made worse off or else they would not need to be coerced. So trade is the kind of attraction that happens when people choose to interact with one another because they both expect to benefit. If one of the people does not expect to benefit, then they would not have taken part in this interaction and you would need to coerce them into, into taking part, in which case we would not be talking about trade, we would be talking about theft or extortion or other kinds of coercive interaction. So the difference between trade or consensual interaction and coercion, coercive interactions can be understood in that trade is a positive sum game. In other words, the benefits accrue to both parties and so both parties are benefiting from the interaction. So both of them are better off. So the sum of the interaction is positive for both. On the other hand, coercion can, can be understood as being zero sum to an extent in that one person takes something from the other person and so one person benefits and the other one loses. And you could say that the net effect is zero sum. So both don't benefit. One benefits at the expense of the other. That effectively could cancel out. So you could say that this is zero sum interaction, but more likely it is a negative sum interaction in that one party loses more than the party that gains. And I think this is likely the case in the situation of theft because the person who steals something usually doesn't value it as much as the person who owns it. It's debatable. But if you own something, you probably value it and care about it because it's part of your life and you depend on it. And then somebody steals it, that person is not going to be finding it as valuable as it is for you. So an important part of your property, your clothes that you rely on, they're not as valuable for somebody who's going to take them and sell them on the second market, on the second hand market as they are for you, because you know you need them and you rely on them. So we could think of course of interaction as being negative sum, that the benefits that accrue to the thief are not as large as the losses that accrue to the person who got robbed. But in either case, of course, the Total sum of utility is not something that is relevant in any meaningful sense. We don't decide on whether something is good or bad based on this kind of measure of utility, this aggregate measure of utility. That's not the approach that Austrian economists like to take. This is more of a modern mainstream economist approach, utilitarian approach. Whereas from the Austrian perspective, it's much more of a first principle analysis which would reject theft from the fact that it is wrong because it employs violence or the threat of violence against innocent people. It initiates violence. And I think that's the real problem with it. So value is subjective and the thief could value something less than the owner. The threat of violence implies violence is a possibility. And the cost is usually high and could be higher than loot. But more significantly, perhaps than that is that violence brings about the threat of retaliation. And this is a major issue because people could retaliate. The fact that they can retaliate means that that creates problems for the. The person who. For the thief or the violator of rights. Because they could get chased, they could get caught, they could get killed, they could get robbed again, they could go to jail. There are all kinds of costs associated with being a thief which make it highly inadvisable as a career choice. But I think the bigger picture here is beyond just thinking about it in terms of one action. I think it's important to understand that no matter what the spoils of violence are, they pale in comparison to the benefits of civilized cooperation. And I think this is a very, very important point. And this is why we have civilization. This is why we have peaceful society. This is why human beings can interact with one another peacefully. Because even though theft might seem quite lucrative, you know, you walk away with something that you didn't have to work hard for. It's not as productive and lucrative as being able to engage in peaceful, cooperative interaction with other people. And that's why most people don't end up spending their lives as criminals. Most people like to cooperate with one another and they do not commit crime. And I think this is one of the many benefits of studying economics. When you study economics, you're less likely to become a criminal, I would say, because you understand the benefits of not being a criminal and the benefits of living in a society where. Where crime is frowned upon and where peaceful interaction is valued heavily. So to illustrate this, let's look at the example of Robinson Crusoe and Friday. This is a classic example that's used in all economics textbook, not all, but in most economics textbooks, they generally like to use this example to illustrate it because it's a useful starting point for thinking about trade from first principles from scratch. Imagine the story of Robinson Crusoe, man who's shipwrecked on an island, and he's all alone, and then one day he discovers there's another person on the island, and the other person is called Friday. So those two people are only two people on an island. They have nobody else with them, and now they have a choice of what to do with each other. So they could cooperate, or they could fight. They could resort to coercion, or they could resort to consent. Those are the two choices that face them. And we could generalize that this is a choice that faces everybody in every social context. So you today, you walk into a restaurant, and you can go and order the food and pay for it, or you could decide to stick a gun to the head of the owner of the restaurant and ask him to feed you for free, or you could decide to take his money, or you could decide to just shoot everybody in there. That's a course of action that is available for you. And yet the vast majority of people who go to restaurants, and I'd say 99.9% of restaurant patrons, walk out without cursing or robbing the restaurant owner. Why is that the case? Well, I think if we think about it from an economic perspective, you know, from the human action approach to economics, we can see that this is pretty wise choice to do for Robinson Crusoe, for Friday, and for you at your local restaurant. So Crusoe can steal Friday's things, or he can enslave him, or he can murder him. So there's a stranger on the island. It's a scary thing. How do you trust him? How do you know he's not going to come after you? Let's just kill him and be happy. That's one way of doing it. Another way is to go to him and tell him, listen, you're going to be my slave and you're going to do what I say, or else I will kill you. It's another possible course of action. Another one is to just take his things, go to him and tell him, hey, your things are mine, and I'm going to take them. And the tough, there's nothing you can do about it. Now, obviously, each one of these, there is some benefit from it. When you murder him, you have the peace of mind of knowing that he's not going to come murder you or take your stuff. When you take his stuff, then you have his stuff and if you enslave him, then you've got a slave, somebody who's going to be working for you. There is a benefit from doing all of those things, but there is also a heavy cost. And the cost is that he's likely not just going to take it lying down. He's likely going to fight back. He's not going to want to be murdered, he's not going want to be enslaved, and he's not going to want you to take these things. And if you try and do those things to him, he could fight back. And him fighting back could be fatal for you. So you could be killed, you could be seriously injured, you could be debilitated in a serious way. So that's not a very wise course of action. And the fact that this risk exists means that the gains that you're going to get are likely not worth it. But even if you manage to secure the gains from this without getting injured, and while eliminating that cost, you know, you manage to enslave him in a way that prevents you from suffering any consequences. You lock him up in a cage or whatever, and you take his things and he can't do anything about it, then in all of these situations, you have gained something from it. But whatever the gains are, they will be far less than the gains that you get from cooperating with him peacefully. I think this is a very important point. Everything that he has is only a tiny fraction of the gains that you could make from a lifetime of cooperating with him, working with him consensually on producing things together. You can only rob him once, but you can benefit from exchanging with him forever. And we're going to see now why trade is so beneficial. And the rest of this chapter examines why and how trade is beneficial and why people like to take part in trade. So there are several ways in which we can think about the gains of trade, and I summarize them in the next sections of this chapter. The first and most obvious one is to understand the starting point of all economic analysis, which is that value is subjective. So from the Austrian perspective, as we discussed, valuation is subjective. People value things subjectively. People decide how much they value particular things. Psychologically, in their mind, they decide what they value. So if value were objective, if values of different things were objective and interpersonally objectively determined, that everybody knew this thing was valued this much, and everybody valued it at the same value at all times, then trade could not exist. Why would anybody want to trade two things that are valued equally to one another? If everybody values a phone at $100. And this is the market value of the phone, and this is the value that everybody place on it. And this is the objective value of the phone. Why would you exchange it for $100? If you value it equally to $100, then you're indifferent between them, so you're never going to bother conduct the transaction, to engage in it, to. To. To engage in the transaction, to exchange it. But of course, in reality, value is subjective, so value differs between goods. So therefore you value one thing differently from what other people value it. And so the person who sells phones values $100 more than that phone. The person who buys the phone values the phone more than the $100. And so therefore they both benefit from that exchange. The seller gets $100, which he values more than the phone. The buyer gets a phone which he values more than $100. So this is why we can see that value. The the concept of subjective valuation is what allows us to understand why trade happens. And because both people have different valuations of a different good, they are both going to benefit from this transaction. Anytime we see two people engage in transaction, we can say that they both benefit from it because they both have a subjective valuation of the good that they got from the transaction that is higher than the value of the good that they gave. Now for a quick word from our sponsors. With fiat money constantly debasing, preserving your wealth isn't an option or luxury. It's a financial and moral imperative. If you're familiar with my work, you know the only financial advice I ever give is to buy and hold Bitcoin for the long term. This has never failed anyone. If you want to buy Bitcoin, I strongly recommend using Swann, a group of hardcore bitcoiners laser focused on making Bitcoin easily accessible. While most scramble to react to each new crisis, Swan Private clients are already positioned in the only monetary asset with absolute scarcity, Bitcoin. 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Coinkite are my favorite makers of bitcoin hardware. They produce the legendary opendime, the first bitcoin bearer asset, as well as the reliable cold card hardware wallet, the excellent stainless steel seed plates for storing your seed phrases, and the block and if you remember, we said that valuation is subjective, which depends on many factors. And it depends on many factors. One of those factors is abundance, how much you have of a good. So if you have a lot of one thing, then the valuation you have on the marginal unit of that thing declines and so you value it less and less. And because you value it less and less, you are willing to give up these things for things for which you do not have much. So this is another way in which we can think about the benefits of trade. So one way is that these things are valued subjectively differently. Another way to think about it is that as you acquire more of a good, the marginal valuation you place on the marginal good of these of that good declines. And so therefore you're willing to exchange it for another good at you're willing to exchange it for another good of which you have a lower quantity. This is another framework we can use to understand why people trade. So in this situation we can go back to Crusoe on Friday. If Friday if Crusoe has an apple but he prefers oranges and Friday has an orange but prefers apples, they can both benefit. And also if we think about it in terms of marginal utility, if Crisseau has a lot of apples while Friday has a lot of oranges, they would both benefit from exchanging. So that's another way which you can understand it. So different subjective valuation but also different marginal utility that you get from things, and as you get more of one thing, you get a diminishing marginal utility. So if they both come into interaction with one another and one of them notices the other person has an abundance of something that the first person does not have, well, that creates an opportunity for trade. You have a lot of apples, I have a lot of oranges. Hey, since you have a lot of apples, mind giving you me a few of your apples and I'll give you a few of my oranges and since you don't have any oranges and I don't have any apples, we're both going to be better off. So that's one way we can think about the reason people engage in trade and why people benefit from trade because of diminishing marginal utility, and of course, earlier, because of diminishing subjective valuation. That's the basic one. But another way to understand it, and one that is perhaps more relevant to a modern economy, is the differences in the cost of production. So if Crusoe is better at catching fish, while Friday is better at hunting rabbits, they both give up something that's cheap for them to secure in exchange for something that is expensive. So imagine that in a day's work, Friday can catch eight rabbits or two fish, while Crusoe can catch two rabbits or 10 fish. We can illustrate that graphically with this thing that we call a production possibilities frontier. This shows us the possibilities for production for both Crusoe and Friday. So Friday is much better at hunting rabbits, and so he can catch eight rabbits, or he can spend his day catching fish, in which the case, he'll only catch two fish. Two fish is not enough. So what does Friday usually do? He goes out and he hunts rabbits. Because if he spent his entire day trying to catch fish, he's not good at it and he's only going to catch two fish. On the other hand, Crusoe is much better at catching fish. So if he spends his entire day fishing, he's going to catch 10 fish. Whereas if he spends his day hunting rabbits, he's only going to catch two rabbits. Two rabbits is not enough for you to be full during the day, so he's going to spend his day fishing. So Crusoe is a fisherman, Friday is a hunter. Crusoe always eats a lot of fish, and he's getting sick of fish, but he's not good at catching rabbits. And Friday always eats a lot of rabbits, and he's not good at catching fish. So what happens then? Well, when they meet that instead of killing each other, instead of enslaving each other, they could realize, oh, wait a minute, you're a fisherman, I'm a hunter. Maybe we could cooperate. And maybe if we cooperate, we would both benefit. And indeed, that's what would happen. So if you look at this graph here, we see that at the point I on this graph is. Let's assume this is the starting point, where, hypothetically speaking, let's say they spend half their day doing each. So Friday spends half his day catching fish, he catches one Fish. And then he spends half his day catching rabbits, and he catches four rabbits. So he makes do with four rabbits and one fish in a day. And that's how he gets by. Crusoe, on the other hand, spends half his day catching fish. So he catches five fish, and he catches one rabbit. So with five fish and one rabbit, Crusoe eats for a day. And that's their situation in isolation. Now, if they find out that they could cooperate and they find out that there's a difference in the productivity that they have, or there's a difference in the cost of production for both of them, well, in that case, they consider the possibility of going hand and specializing and trading. So Crusoe then decides, let me catch the fish, you catch the rabbits. And then we split the loot in half. And indeed, what ends up happening? Crusoe. And now they move to point S. So Crusoe is at point S, where he catches 10 fish and zero rabbits, whereas Friday is at point S, his s, which is eight rabbits and zero fish. So now Friday has produced eight rabbits. Crusoe has produced 10 fish. And then if they split them in half, Crusoe has five fish and four rabbits, and Friday has four rabbits and five fish as well. So, as we see, simply by specializing each of them in what they do best, they've moved from eating four rabbits and one fish or five fish and one rabbit to both eating five fish and four rabbits. In other words, when he discovered Friday, Crusoe managed to increase his daily consumption by three rabbits. He went from five fish and one rabbit to five fish and four rabbits. Similarly, when he discovered Crusoe, Friday went from four rabbits and one fish to four rabbits and five fish. In other words, discovering Crusoe was worth four fish a day for Friday. So Friday gains four fish every day from simply dealing cooperatively with Crusoe, and Crusoe gains three rabbits every day from dealing cooperatively with Friday. So you can see why it's such a stupid idea for them to fight or for them to kill each other, or for them to rob each other or. Or for them to try and enslave one another. Why would you enslave him when you can just work with him cooperatively? And if you work with him cooperatively and you let him specialize in what he does best, you're going to gain four rabbits every day for Friday and three fish every day for Crusoe. It's an enormously beneficial trade that they both benefit from. So therefore, they both benefit from this more than they would if they did it in a day. In other words, if Crusoe just went and killed Friday, he might have had his fish for day. But then that's it. It's one day in which you get eight fish or eight rabbits for a day, and that's it. Or Friday kills Crusoe. Friday has gotten. And then Friday would have gotten Crusoe's fish for a day. He'll get 10 fish for one day. Well, 10 fish for one day is nothing, because if you kept him alive, you'd have four fish every day. So four today and then another four tomorrow and then another four the day after. But of course, over time, the gains even amplify, because by specializing in catching fish, Crusoe becomes better and better at fishing and Friday gets better and better at catching rabbits. And then they can start investing in capital goods and more elaborate capital infrastructure for working in this business. And they keep both getting better at it. So by simply specializing in the production of the cheaper good, they have both produced more fish and rabbits than if they had each split their time and effort between producing both. This result almost seems like a magic trick. Both work the same number of hours and yet they both end up with more rabbits and fish to eat and are both better off. It's cheating. Cooperation is a gift that keeps giving every day. They can now specialize and have more. If they had fought, one of them would at most have a one off loot, but not the benefits from daily interaction that we see in this situation. This framework for understanding trade is called absolute advantage, wherein each one specializes in the thing that they can produce at the lowest cost, and therefore they end up producing more of it, rather than dividing their labor over things over different tasks, some of which they're good at, some of which they're not good at. So focusing on the things that they're good at allows them to bother benefit. Now, another way of understanding the benefits from trade comes from thinking of the concept of comparative advantage, which is a little more subtle but much more powerful. So absolute advantage is pretty straightforward. You focus on the thing that you're very good at, but comparative advantage is different. Comparative advantage allows us to think of people specializing and trading with one another based not on the differences between them in terms of the cost of production, but in terms of the opportunity cost of production. And that's a very big difference. So in terms of the cost of production, you would specialize in doing the thing that you are. Now for a quick word from our sponsors. The Bitcoin Standard podcast is brought to you by the safehouse.com, my independent publisher and bookshop selling the best Bitcoin books in high quality cloth hardcovers built to last for generations. Most books these days are pretty fiat. They're flimsy and they fall apart quickly and I did not want that for my books. So I set up the Safe House especially to provide you with beautiful, long lasting classic cloth hardcovers you can proudly pass down for generations. You can get copies of my three books, the Bitcoin Standard, the Fiat Standard, and Principles of Economics. 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They don't touch your coins. They guide you through the process of acquiring your coins and securing them. If you'd like to make your setup safer and more reliable, book a consult with them and see what they have to suggest. If you want to give someone the gift of Bitcoin, get them this professional service that will ensure they start off knowing exactly how to manage their coins and not lose them. Go to the Bitcoin way.com and start bitcoining more confidently. Most Productive at doing and so each person does the thing in which they're most productive. But in the case of comparative advantage, you focus on the thing at which you have the lowest opportunity cost, which means that even if one person is more productive at both tasks than the other person, they both benefit from exchanging with one another. Why? Because as long as there's a difference in the opportunity cost of the production for both of them, then they will both benefit from dividing their time toward the thing in from dedicating and specializing and dedicating all of their time towards the thing in which they have the highest productivity. So even differences in opportunity cost create opportunities for specialization and trade. Even if one party can produce both goods more cheaply because time is the ultimate scarce resource, cooperation is beneficial to both because it allows them to dedicate their time to what is most productive for them. So imagine if in the example above, Crusoe were more productive at both fishing and hunting and he could produce six rabbits at 12 or 12 fish per day, while Friday could only produce four rabbits or two fish. So we revised the production possibility frontier curves for both of them. Now to look as they do here in Figure 18. As you see, Friday can only make two fish or four rabbits. So Friday is not very good at fishing or hunting. Crusoe is better at fishing or hunting. He can make six rabbits a day, or he can make 12 fish a day. Crusoe maybe has been on the island for a longer time. He's developed a bigger capital stock. He's already got a fishing rod and he's got a bunch of spears that he uses to catch rabbits. So he's better at both tasks. So in this situation you might think, well, I'm chriso much better than Friday, and so therefore I have no use for this guy. He's not good at catching fish, he's not good at catching rabbits. Why should I waste any time trying to cooperate with him? I can just do what I want and benefit by myself without having to accommodate him or waste my time on him. You would be wrong. Friday could also similarly think, well, this guy's better than me in both cases. What does he need me for? He can catch more fish than me. He can catch more rabbits than I can. I don't need him, sorry, he doesn't need me. So he clearly is not going to be interested in cooperating with me. I should probably just kill him and take his stuff while I still can. And Friday would also be wrong, because in this situation they would also both benefit from cooperating. So let's again do the same analysis. If we were the situation where they both are in isolation and they both split lit their days in half. Friday catches two rabbits and one fish every day, whereas Crusoe catches six fish and three rabbits every day. In this situation, what do we get? Well, six fish and three rabbits in a day for Crusoe is a lot. Should he trade with Friday? Yes, he should. Why? Because of the difference in opportunity cost. And we can think of the opportunity cost as being the slope of the production possibilities frontier in these curves. And so as long as there is a difference in the slope, that means that the rate of substitution for Crusoe is different from the rate of substitution for Friday. And so if they move towards substituting the towards one or the other, then they are both going to benefit from it because they'll both have a bigger output at the end of the day from specializing in the things in which they have the lowest productivity. Sorry. In which they have the lowest opportunity cost. And so Friday, in this situation, would shift to producing four rabbits only. And that's point s for Friday. Crusoe, on the other hand, would shift to producing only fish. So that would be 12 fish. And so Crusoe makes 12 fish and Friday makes four rabbits. Now, the total that they have is 12 fish and four rabbits, whereas previously, if they'd worked in isolation, they had a total of seven fish and five rabbits. So they now have four rabbits, but they have one rabbit less because Friday is only making the rabbits, but they have a lot more fish. So they've got 12 fish. If they wanted to keep the number of fish equal, then Crusoe could only catch 10 fish and one rabbit. And now Crusoe has 10 fish plus one rabbit, whereas Friday has four rabbits. So in this situation, they have five rabbits in total, and they have 10 fish. So they've gone from the previous situation where they had five rabbits and eight fish to five rabbits and ten fish. So they've gained two fish simply by specializing. And that's why with all the extra loot that they have, they can go and trade and end up with eight fish for Crusoe and two fish for Friday, plus two rabbits for Friday and three rabbits for Crusoe. So Crusoe gains from the situation if they move to point t, which is the point of trade, Crusoe now has two fish more simply by trading, he's been able to get two extra fish, and Friday has gone from one fish and two rabbits to two fish and two rabbits. So Friday gains one fish, and Crusoe gains two fish simply by moving to the specialization situation. So whereas before the trading, when in isolation, they had a total of five rabbits and seven fish between them, now they've got five rabbits and ten fish between them. And so they've increased the amount of fish by three fish. And so Crusoe gets two fish extra and Friday gets one fish extra. So, yes, Crusoe makes more from this, because obviously Crusoe was the one who was producing more, But Crusoe is better off and Friday is better off. So they're both better off from cooperating. This is an enormously powerful lesson. It doesn't matter if one person is more productive. There's always a difference in the opportunity cost between the two people. And that difference in opportunity cost is essentially an advertisement for the trading opportunity. Crusoe realizes that he has two options for securing an extra rabbit. If he wants to have more rabbits, Crusoe, can he reduce. He can reduce the time he spends fishing and give up two fish in order to have enough time to hunt one extra rabbit or two. He gives Friday anything more than half a fish to get him to part with one of his rabbits. The first method costs Crusoe2fish, whereas the second costs him a sum larger than half a fish. So any terms of trade that Friday asks for. So Friday asks him, all right, we'll exchange it for one for one that's workable for Crusoe, because Crusoe will be giving up one fish and gaining two rabbits, which is better for him, because if he wanted to gain the extra rabbit on his own, sorry, if he would be giving up one fish to gain one rabbit, which is better for him than engaging in trade with himself, moving toward spending more time on rabbits, because if he did try to do that, he'd have to give up two fish in order to get one rabbit. But now with. By trading with Friday, he can just give up one fish and get an extra rabbit, so there's four. It's an easier way for him to secure more rabbits. Now, if this was a mainstream economics course, if this was a regular textbook for economics, we'd spend many, many hours doing all kinds of different examples of trying to illustrate this point mathematically. And I think that's useful in a mathematical sense, it's useful in a pedagogical sense. It's useful because it helps you develop your mathematical skills, perhaps. But my honest opinion is that it obscures the important economic insight here. And in fact, if you look at your average trade economics textbook, or international economics is usually called the textbooks that discuss trade, they focus on this math, and they bludgeon you with so many examples of math, and then they start tweaking with these examples, and then they start arriving at examples for how in certain situations, you're better off by not engaging in trade or you're better off by having the government restrict you from trade. And I think that's. That's part of the reason why mathematicization is so popular with economics, because you can always twist Around a mathematical example in order to give you the result that you want. And that's what happens with all of these models. They're all artificial models. They're intellectual constructs that we make up, and they don't make much sense on their own. So the profound insights and benefits of trade are usually covered only briefly in the early chapters of most textbooks. While the needlessly complex mathematical models take center stage, the mathematical sophistry makes for easier standardized testing and also transforms these textbooks into a series of elaborate half baked rationales for government intervention in trade. So these two very important concepts help us understand why there are so many benefits to trade. People benefit from trade because they have differences in the cost of production, the absolute cost of production, and that's what we call absolute advantage. But also because they have differences in the opportunity cost, Simply the fact that you can produce things at a lower opportunity cost. And by opportunity cost, we mean, in this example, the cost of rapids in terms of fish. Because simply by having a different opportunity cost between those two, that creates an opportunity for specialization, wherein each person moves toward producing more of the good, of which they have a lower opportunity cost. And that allows them both together to produce more of both goods. And therefore both of them can have a higher amount of consumption. So another way we can think of the benefits of trade is the concept of specialization and the division of labor. And this is an enormously important concept in economics. The motivation from trade can be derived from differences in taste and valuation, as we mentioned earlier, but in an extended market order, they are driven ultimately by differences in the cost of production and the opportunity cost, and they are intensified by specialization. So it's not just that people are born better at doing things, of course, there is an element of that. Some parts of the world are better at producing certain things, but simply specializing in producing something makes you better at it. So Friday and Crusoe might be identical twins, but if they went on an island, they might have the same skill set. They might have spent their entire life doing the same exact thing, and have the exact abilities and the same exact productivity in everything. And yet on that island, if one of them spends his time catching fish While the other one spends his time catching rabbits, naturally the one who's catching fish is going to keep getting better at it, and the one who catches rabbits is going to keep getting better at it. And then the specialization is going to make the opportunity cost differ between the two. And that will then create the opportunity for them to trade with one another and specialize and benefit from it. So this, the fact that people specialize in producing things makes them better at it. Irrespective of the original differences in tastes and preferences and abilities and endowments and natural talents. You get better at producing the thing in which you specialize. And that's enormously important. Because it allows you to keep focusing on getting better and better at one thing. Rather than trying to increase your productivity at all the things that you need. And, of course, there's an infinite number of things that you need and could want and want and need to produce. So whereas in isolation, man produces what he needs. In a social system, man produces based on what he expects others to need. And that is an enormously important aspect of markets. Because now you've introduced other people into the economy. And because there are so many gains from interacting and trading with other people. You find yourself in a situation where it is beneficial for you to engage in specialization and to focus on one thing. Rather than focus your time on producing the things that you want. You focus your time on producing the things that benefit others. And because you're focused on others. Because you're focused on providing one thing for many people. Rather than providing many things for yourself. That allows you to specialize, that allows you to keep getting better at it. And that's an enormously important advantage. And that's why being part of a social economic system. Is so much more productive than working in isolation. By specializing in producing a good for a market. Rather than producing for your own consumption. It becomes possible to dedicate labor Toward the place where it is most productive. Not where it is necessary. So you need to eat, and you need clothes, and you need shelter. But you can't get very good at all of those things if you're on your own. But if you're in a market order, you can specialize. And the way to specialize is to spend your time focusing on one of those things. That you can produce best for everyone. And then get other people to produce the other things for you. That's a really powerful point. And it's why people benefit from being part of a social system. Beyond just an increase in productivity. Trade leads to social cooperation and civilized behavior. As the benefits of being able to engage with society peacefully. In a division of labor are very high. Other people are your path to meeting your own needs effectively. That's why you should behave. That's why you need to be a civilized human being when dealing with other people. The better you deal with other people, the more you are able to benefit from specialization and the division of labor. You focus on the things that you are good at. You get very productive at them, and that makes you better off than if you try to be on your own. And that's why you need other people. So, of course, I'm sure you've come across a lot of people who talk about how society is a mechanism for repressing humans and society is so bad. And, you know, you hear this all across the political spectrum. You hear it in the left and in the right. You hear it amongst teenagers, you hear it among old people. You hear it among some religious people. But this is really meaningless and it is very silly. And we're going to see this as we discuss civilization in the latter chapters. We're going to discuss this concept in more detail. We're just laying the foundations for this right now. But the key point here is that it's easy to say, oh, well, I don't want to be part of society, or I don't like what society is doing. To me, society is forcing me to do all kinds of things that I don't want to do. The reality is society is the reason that you have a roof over your head. Society is the reason that you are living in such good living standards, because society is allowing you to specialize and allowing others to specialize, and it's allowing the productivity to increase. And so if you want the fruits of civilization and the division of labor and specialization, you need to figure out how to deal with other people. And that's what civilization is about. How can we all get along without us all having to be best friends or best family members to one another? How can we figure out how to behave properly so that we can get along, so that we can enjoy the division of labor that is what creates civilization beyond anything else. We don't need others just because, you know, we are forced to interact with one another. We need others because it gives us the division of labor and specialization, and that's enormously beneficial. If you don't believe me, go try and spend the next month without interacting with civilization or the division of labor. Can't use any capital, can't use any infrastructure that was built by anybody else. Go out into nature and try and make it on your own, with your own hands, only with the things that you produce yourself, only eat the food that you produce, only stay in shelter that you build, only wear clothes that you make. If you do make it back, please do let me know, although I'm afraid I will never hear from anybody, because you're likely not going to make it back. So what drives specialization? What causes specialization? Well, Rothbard presents three drivers of specialization. Differences in suitability and yield of nature given factors, differences in given capital and durable consumer goods. So the first one difference, suitability and yield of nature given factors. You know, Crusoe happens to be on the part of an island where there's a lot of fish. Friday happens to live in the hinterland where there are a lot of rabbits. Differences in given capital and durable consumer goods. Crusoe happens to have a lot of fishing rods, whereas Friday happens to have a lot of spears for catching rabbits. That's going to create a difference in productivity. Or it could be differences in skill and in the desirability of different types of labor. Friday is powerful since that allows him to chase after rabbits and catch them or throw spears very fast. Crusoe's patient, so he can fish spend many, many hours waiting for fish to come along. These kind of skills, they can drive this specialization. These three are a useful concept to think about, particularly in this kind of Crusoe Friday scenario. But in the modern world, in a world of an advanced industrial economy, then it's really ultimately about the differences in capital stock. And the reason that some countries are good at producing cars is just because they've had an enormous amount of investment in car production over the years. That's mostly it. The more capital intensive the world, the more specialization depends on capital stock. Finally, an important concept to understand here is the concept of the extent of the market. The example of two people living in an island is useful to illustrate the benefits of trade. You know, the looking at rabbits and fish between Crusoe and Friday, in that very simple example, we saw how magically by cooperate, they managed to create more fish and rabbits just by cooperating between them and dedicating their labor towards the thing at which they have the lowest opportunity cost. But what that example misses is that the more people you add to this cooperation, the more fish and rabbits and cars and smartphones and laptops and all kinds of amazing things you're going to be able to add to this economy. So when it's only two people, they are barely able to survive in just fish and rabbits. That's they spend all day, every day working on just that. And they can barely make do with anything else. As you start adding more people, you can start producing more things, more goods, you can make more cars, more homes and, well, not cars initially. As you start adding more people, they can start making other foods, they can start growing crops, they can start making houses, they can start building shelter, they can start making clothes, and then they can start building things that protect them from nature, from animals. And as you add more and more people, you can accumulate more and more specialized capital and increase productivity further and further by specializing further. So if more people join, they can each specialize further and increase productivity further, creating more goods which allows them to move beyond basic survival. And so one person on an island is a struggle for survival. Two people is still a struggle. Ten people becomes a lot easier of a struggle. But I've heard it said somewhere, and I can't remember where, But I think that the minimum viable number of people in order to have a sustainable society is 150. Anything less than 150 and it's very difficult to maintain basic survival. So if you have 150 people, you can divide tasks between them enough so that people can specialize in those things, and then they're able to produce the basic necessities that allow them to survive safely. And of course, as you increase the number of people, it becomes more and more productive. And so the world that we have right now, where we have things like computers and smartphones and cars and airplanes, is not possible, Would never be possible if we lived in a world that was divided into economies of a thousand people. Only if every thousand people had their own isolated economy that would not trade with anybody else, we would all be living very primitive lives. We would not have any cars or any airplanes, would not be able to build those sophisticated products. But as the number of the people in the economy increases, more products become possible. And that's because of specialization and increased productivity. We are able to make more and more productivity, more higher productivity, by producing more goods, specializing more, by having a larger extent of the market. The more people are in the market, the more specialized we can be, and then the more variety of goods we can produce, and then the more output we can make. And a great example of this idea of how we benefit from specialization comes from an interesting and very famous essay by Leonard Reid, which is called Eye Pencil. And it is the story of a pencil that is trying to explain its life and how many people had to cooperate in order to make a pencil possible. And the controversial idea, or the shocking starting point of that essay, is that nobody knows how to make a pencil. You might think that somebody knows, but nobody really knows. There is a factory that puts together all the things that went into making the pencil, but they have no idea how to secure all of the raw materials that go into the pencil. And they have no idea about all the production processes that are involved in building the capital goods that go into securing these raw materials. And so the only way that we can get that is through specialization. When you have so many people specialized in tiny little tasks that added up together, produce the pencil, then we're able to make this pencil available at such very large quantity and a very low cost. And that's what Milton Friedman discusses in this video.
- [53:21]
Milton Friedman
The basic principles underlying the free market, as Adam Smith taught them to his students in this university, are really very simple. Look at this lead pencil. There's not a single person in the world who could make this pencil. Remarkable statement. Not at all. The wood from which it's made, for all I know, comes from a tree that was cut down in the state of Washington. To cut down that tree, it took a saw to make the saw. It took steel to make the steel, it took iron ore. This black center, we call it lead, but it's really graphite, compressed graphite. I'm not sure where it comes from, but I think it comes from some mines in South America. This red top up here, the eraser bit of rubber probably comes from Malaya, where the rubber tree isn't even native. It was imported from South America by some businessmen with the help of the British government. This brass ferrule, I haven't the slightest idea where it came from, or the yellow paint or the paint that made the black lines, or the glue that holds it together. Literally thousands of people cooperated to make this pencil. People who don't speak the same language, who practice different religions, who might hate one another if they ever met. When you go down to the store and buy this pencil, you are, in effect, trading a few minutes of your time for a few seconds of the time of all those thousands of people, what brought them together and induced them to cooperate to make this pencil. There was no commissar sending out offices from. Sending out orders from some central office. It was a magic of the price system, the impersonal operation of prices that brought them together and got them to cooperate to make this pencil so that you could have it for a trifling sum. That is why the operation of the free market is so essential, not only to promote productive efficiency, but even more to foster harmony and peace among the peoples of the world.
- [55:43]
Saifedean Ammous
As the market with which an individual is able to trade increases in size, the individual is able to select from a growing number of producers and sell to a growing number of consumers. This is very beneficial for you. That's why we are able to have Things like a pencil available for a very low cost. You can buy a pencil and you can use it for a whole year, and it'll only cost you a few cents at this point to buy that pencil. Millions of people cooperated, millions of people produced, chopped the wood, made the graphite, made the rubber, and they produced millions and millions of pencils and millions and millions of other goods that were made from the wood and the graphite and the rubber. And you only need to buy with, you know, a few seconds of your labor is what it takes you to buy that pencil. You work for a few minutes a day at your current wage. You work for a few minutes or a few seconds, and you're able to secure the amount of money that is required to produce that pencil. That's because you're part of an enormously sized market economy. Imagine if you tried to make that pencil on your own. How complicated would it be for you to chop down the woods, for you to get the graphite, for you to get the rubber, for you to put all of those things together, for you to build the machines that are needed in order to make that pencil? It's unthinkable that Crusoe and Friday could make a pencil on their own on that island. But as the size of their economy grows, maybe at a point to when they're a thousand people, they might be able to start making pencils. And then at when they're part of an 8 billion more people economy, which is what the world economy is today, then they're able to spend a few seconds a day working in order to secure the money that is needed in order to, to get a pencil. So this idea helps us understand so much about economics. The benefits of specialization and the benefits of the division of labor help us understand that's why people move from rural areas to cities. When you go to a city, you have a bigger market. You can be part of a larger extent of the market. You can specialize more, you can deal with more people, spend more money
- [57:53]
Milton Friedman
on
- [57:53]
Saifedean Ammous
buying things rather than spending all your time on producing things. And you can produce, you can specialize in the production of one small thing that you sell to a larger number of people. That's why the wealthiest people in the world are all integrated into the global market economy. There aren't very rich people who are living in isolation. All the richest people in the world are able to produce things that they sell in enormous quantities to many millions or billions of people around the world. That's why isolated communities are poor. I discussed the example of St. Helena in the book. And that's a tiny little island that's very isolated, maybe the most isolated place in the world. It's halfway between Cape Town and Rio de Janeiro, basically. And it's an extremely poor place because it's very expensive for them to take part in global trade. It's very expensive for them to ship things abroad, it's very expensive for them to receive things, and that makes them not able to benefit from the division of labor as much as places that are better connected to the world. That's why trade restrictions impoverished countries. If you look at the countries that have the least amount of trade with the rest of the world, they are some of the poorest countries in the world. And that's why the US being a large free trade zone, has made it so wealthy. One of the key things that the US has has going for it and has had going for it for the last couple of centuries is that since the establishment of the US it has been an article of faith amongst the country that you cannot have trade barriers between the US states. And so you have this enormous landmass from ocean to ocean, 50 states all trading freely amongst each other, and that's enormously beneficial to them. The similarly sized Europe has usually had a lot more barriers to trade and to goods moving around, and that was massively destructive for them. It is no wonder that humans are constantly attempting to engage in trade with one another. And trade encourages humans to moderate their aggressive and hostile instincts toward others and seek productive cooperation instead. The ability of strangers were not connected by bonds of family or kinship to arrive at a mutually beneficial exchange is one of the basic building blocks of human civilization. The extent to which strangers can expect to deal peacefully with one another, respecting each other's bodies, property and will, is the extent to which they live in a civilized human society. Understanding this concept, understanding how important trade is to civilization is a key point in this book and in economics in general. And understanding why trade is so instrumental in giving us civilization is one of the main points this book is trying to drive home. This is it for this lecture. Thank you so much for joining and I'll see you on the next lecture. Lecture 10, which will discuss money.