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"Trade is Made of Win," Part 1: Wealth Creation One of the most important ideas in all of
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economics is that trade creates wealth. It’s also one of the least understood ideas in
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all of economics. Most people think that if two people trade, one of them has to win and
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one of them has to lose. But one of the ideas that has evolved in economics is that trade
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creates wealth, and we’re going to see that in the context of a couple of simple examples.
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Consider two people, Fritz and Lou. Fritz and Lou can produce two goods. They can produce
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socks and they can produce corn. In a given year, Fritz could produce 500 socks or 1,000
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ears of corn. Lou, on the other hand, could produce 25 socks or only five ears of corn.
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For Fritz, every sock that he produces costs him the opportunity to produce two ears of
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corn. Same story for Lou. Lou could produce 25 socks or five ears of corn, so every sock
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costs him one fifth of an ear of corn. Every ear of corn costs him five socks. Suppose
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that Lou comes up with an idea: Lou goes to Fritz and says, “Hey, tell you what. How
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about you specialize in corn and I’ll specialize in socks, and then I’ll trade you one sock
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for every ear of corn you’re willing to trade me.” What we want to do is compare
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the price at which they propose trading to their opportunity costs.
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If you’re Fritz, every sock costs the opportunity to produce two ears of corn. If Fritz is able
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to trade for socks, then every sock is only going to cost him one ear of corn. Fritz would
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prefer the trade. Why? Because socks are now cheaper.
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Let’s see what happens to Lou. If Lou is going to produce corn himself, he has to give
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up five socks in order to produce that corn. If Lou trades for corn, he only has to give
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up one sock per ear of corn. Fritz, the buyer of socks, is now able to get socks cheaper.
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Lou, on the other hand, is able to sell his socks for more than he could get them for
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if he produced them himself. Fritz wins. Fritz is made better off. Lou wins. Lou is made
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better off. Trade is made of win or, as your economics professor might have told you, trade
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creates wealth.