“Trade can make everyone better off” is the fifth principle out of the Ten Principles of Economics given by Gregory Mankiw, a renowned American economist, in his book Principles of Economics.
This principle explains why people trade with their neighbours and why countries trade with one another. In this article, we are discussing the meaning and thinking behind this principle.
Understanding how trade can make everyone better off
In his book, Gregory Mankiw explains that in the world economy, we see that many countries are competitors of one another. They may produce the same category of goods targeting a common market of customers. For example, Ford (an American automobile manufacturer) and Toyota (a Japanese multinational company) compete for the same customers in the automobile market. It is easy to look at their competition. But it should be seen that trade between US and Japan or between any two countries is not like a contest where one side wins and the other loses. In fact, trade between two countries can actually make each country better off. How? Here is an example to understand this according to Mankiw.
Consider the effects of trade on your family. When a member of your family searches for work, he or she competes with members of other families who too are looking for jobs. When families go shopping, they compete against one another because each family wants to get the best things at the lowest price. As a result, in one way or the other, every family in the economy competes with every other family.
Mankiw says that in spite of this competition, your family would not be better off separating itself from all other families and society as a whole. If it did, your family would have to cultivate its own food, sew its own clothes, and construct its own home. Obviously, your family benefits much from its ability to trade with others.
Trade enables each person to specialize in the tasks that he or she excels at, whether it is farming, sewing, manufacturing, or building construction. People can buy a wider range of goods and services at a lesser cost by trading with others.
Moreover, the ability to trade with one another benefits both countries as well as families. Trade helps countries to specialize in what they do the best while also enjoying a wider range of goods and services from other nations. The Japanese, as well as the Americans, the Indians and the Brazilians, etc., are as much partners in the world economy as they are competitors to one another.
Thus, trade can be mutually beneficial for countries.
Here is another example of how trade can make everyone better off.
This fundamental principle of economics can be understood with a simple example.
Assume that your roommate is a better cook than you are, but you can clean faster. Now, if your roommate did all of the cooking and you did all of the cleaning, both of you would be able to finish your tasks in less time as compared to when you divide each task evenly. This is so because doing what each person specializes in can help to complete the tasks in less time.
Trading with one another helps countries to boost efficiency
The theory of comparative advantage helps to explain why countries trade with one another.
The capacity of an economy to produce a certain item or service at a lower opportunity cost than its trade counterparts is referred to as comparative advantage. Comparative advantage, as used in international trade, refers to the items that a country can produce more cheaply or readily than other countries.
The rule of comparative advantage is widely known as being introduced in 1817 by David Ricardo, an English political economist.
David Ricardo famously demonstrated how concentrating on one area and trading according to comparative advantages helps both England and Portugal. In this scenario, Portugal was able to produce wine at a low cost, but England was able to produce cloth at a low cost.
Ricardo believed that each country will ultimately realize these facts and will cease to manufacture the goods which are more expensive to generate in its own country. He found that England ceased producing wine and Portugal stopped making cloth over time. Both countries recognized that it was in their best interests to give up the efforts to manufacture these goods at home and instead trade with one another in order to obtain them.
Adopting the principle of comparative advantage helps to increase the efficiency of production by specializing only in those goods or products that one can make more cheaply. Products that are more expensive or require more time to manufacture can be bought from elsewhere. This will in turn help to increase a country’s overall profit margins as the expenses associated with less efficient production will get removed.
The overall idea is that people, countries, and businesses can get greater benefits if they operate collectively through trade and exchange rather than producing everything on their own.
When we concentrate on the things that we do the best and exchange or trade any surplus of those things with someone else in return for the things that they do the best, both sides will be better off. This applies to people as well as countries. Both people, as well as countries, gain when they trade with one another, and hence, they choose to be interdependent.
List of references:
You might also like: