Lesson 1 of 0
In Progress


The previous chapters had discussed economizing acts which can be performed in isolation. Labor, capital, and technological ideas for production are all tasks which humans can use to improve their well-being, without needing to interact with others. But humans are social animals, and with the exception of a few very rare cases, mainly literary and philosophical, all humans are born into a family and extended social order, and spend their life interacting with others. This chapter examines and explains the rationale and benefits from exchange. Forthcoming chapters build on this one to develop an understanding of impersonal exchange in the monetary market order.

Economic exchange with others is distinct from other forms of exchange discussed so far in that involves interaction with another human being. It involves another individual acting human, with their own will.

There are two ways of dealing with others: Coercion: overriding their will, vs cooperation: respecting their will.

When you introduce another individual into life, there is a choice between fighting or cooperating.

The reaction could be violent, murder, attack, enslave, or rob.

Violence and the threat of violence. The way of animals. Zero sum or negative sum games. 

Reason, morality, intelligence, and long-term orientation move us from violence to cooperation and voluntary exchange.

Nothing the other has is more valuable than keeping him alive to make more of it and exchange it.

Society emerges from people able to deal with one another based on consent, cooperation, and the rejection of the initiation of violence.

Voluntary exchange benefits both parties. It must because otherwise they wouldn’t undertake it.

Both parties value the thing they don’t own more, and so an exchange benefits them both.

The price is not the value. If the value was equal to the price, why would either of them want to trade?

Voluntary exchange is another way we can know that value is subjective. Marginal utilities of exchanged goods have to increase for both parties. Each party gains a higher satisfaction from the thing they gain.

If value is objective, how could trade happen?

Anywhere and anytime humans have been observed, they have traded with each other. Economics isn’t an attempt to preach trade, it is an attempt to explain its universal pervasiveness. 

Difference is enriching as it creates opportunities for trade and specialization

Mises: “The fundamental facts that brought about cooperation, society, and civilization and transformed the animal man into a human being are the facts that work performed under the division of labor is more productive than isolated work and that man’s reason is capable of recognizing this truth.”

“People do not cooperate under the division of labor because they love or should love one another. They cooperate because this best serves their own interests.” 

Trade happens because people benefit from it. Why?

Differing subjective valuation

People will value different things differently, and will find benefit from exchanging them. 

Absolute advantage

Exchanging things in which you have a lower cost of production for things with a higher cost of production

People have differences in their cost of production, and will benefit specializing from producing the goods which they can produce at lower cost, and trading them for other goods. 

Person X produces 12 units of A in each hour, or 4 units of B.

Person Y produces 6 units of A in each hour, or 18 units of B.

If they are producing independently, in an 8-hour working day divided equally between A and B, they would produce:

X: 48 A and 16 B

Y: 24 A and 72 B.

Total: 72 A and 88 B

Produced in 16 hours between them

If they each specialize in producing only what they produce cheapest, they would instead have:

X: 96 A

Y: 144 B

Total: 96 A and 144 B

Produced in 16 hours between them

They can work the same amount of time and produce 24 A and 56 B more! Simply by focusing on producing what they are each most efficient at.

Comparative advantage 

Even if one person is better at everything, they would benefit from specializing and trading, because they would have a lower opportunity cost.

Person X produces 3 units of A in each hour, or 3 units of B.

Person Y produces 8 units of A in each hour, or 4 units of B.

If they are producing independently, in an 8-hour working day divided equally between A and B, they would produce:

X: 12 A and 12 B

Y: 32 A and 16 B.

Total: 44 A and 28 B

If they each specialize in producing only what they produce cheapest, they would instead have:

X: 24 B

Y: 64 A

Total: 64 A and 24 B

Even when one party is more productive at both, it would still benefit from specializing in what it produces at a lower opportunity cost. 

This emerges in the real world without economists needing to study it, because people see the differences in real world prices, and act upon them. When people travel from one place to the other they notice the differences in prices. They then sense an opportunity for benefiting by engaging in exchange across the countries. 

These mathematical operations are useful to demonstrate the point, but they have been massively over-emphasized in modern economic education because they allow for the mass production of quantitative questions.

As the difference in price creates an opportunity for trade, production of goods will go more toward the places where it is cheaper. Specialization intensifies and expands as more people trade together in a growing social structure.

Specialization and the division of labor

Specialization is driven by: 

Mises: Differences in abilities and differences in nature-given factors

Rothbard: (a) differences in suitability and yield of the nature-given factors; (b) differences in given capital and durable consumers’ goods; and (c) differences in skill and in the desirability of different types of labor.

Nature and individual abilities matter, but as an economy advances technologically and in capital accumulation, the primary driver of specialization increasingly becomes differences in accumulation of specialized capital.  

Gains from trade inevitably arise in a capitalist society, as capital accumulation drives comparative advantage. People who have capital for a job will have a lower marginal cost for it.

Accumulating capital in any industry leads to higher productivity. On an individual, geographic, or national levels, there will inevitably be differences in types and quantities of capital goods accumulated. 

People, cities, and countries who own large quantities of shirt-producing machines will be able to produce shirts at a lower cost. Those who own capital for the production of cars will produce plenty of cars, and so on.

Without capital accumulation there would be very little scope for specialization and differentiation.

Extent of the market

The larger the market, the more partners, the more goods, the more the scope for specialization, and the higher the productivity. 

Only when there are enough people to produce the essentials can other people move to producing new and more sophisticated goods. 

Our modern high productivity isn’t possible without highly complex specialization worldwide. We couldn’t specialize so much if we couldn’t sell our goods worldwide, and provide for ourselves. 

Someone out there has spent decades working on car windshield design. He can only do that through delegating to others the production of his present goods, through trade. And he can only do that because his work will be incorporated into many thousands of cars.

The larger the area with which a person can trade, the more they can benefit from specialization and the division of labor. The larger the number of people you can trade with, the more there is an opportunity for the accumulation of capital in specialized production. 

The more people you trade with, the more potential buyers for your good. Also, the more potential sellers to choose from. 

All of the most prosperous places in the world have large areas with which they trade freely. Examples:

USA internally

Hong Kong, Singapore, New Zealand, Switzerland     versus    North Korea, Venezuela, Cuba, Eritrea

South Korea vs North Korea

“Every step forward on the way to a more developed mode of the division of labor serves the interests of all participants … The factor that brought about primitive society and daily works toward its progressive intensification is human action that is animated by the insight into the higher productivity of labor achieved under the division of labor.”


Some notes on how economics usually addressed the topic of trade:

Emphasis on trade with others rather with self. More obvious, more political, more relevant to social issues. But arguably less consequential than capital accumulation. 

Arguably economics has over-emphasized trade with others, at the expense of individual economics.

For every transaction you make with someone else, you make many more with your future self.

All the world conspiring against you can only affect a tiny fraction of your transactions, you control the fate of your trades with your future self.

Importance of time preference.

Emphasis on trade with little regard to capital accumulation. 

Without capital accumulation, there would be very little scope for specialization and the division of labor.

Powerful special interests groups like large corporations can benefit from free trade, particularly, government-managed trade which skews international trade in their favor.

No strong constituency, on the other hand, in favor of individual capital accumulation. 


What if a poor country doesn’t have any comparative advantage? Shouldn’t poor countries prioritize development over international trade?

Scarcity of time is ultimately why comparative advantage exists. No matter how bad you are at everything, you still have command over your own time, and human time is the scarcest of resources, and you could always profit from it. 

When others find more productive uses of their time, you are able to benefit even if your productivity remains low.  The value of their time went up, and the value of your time went up as well, without you having to do anything about it.

How do we reconcile the global opposition to free trade with the supposed benefits mentioned by Ricardo and the Austrians?

1- Free trade is the opposite of a free trade agreement

2- the problems of a divided international political monetary system– abandoning the gold standard.

Drivers of trade