The Paradox of Trade


I think a lot of the misunderstandings about the market and human behavior stem from a misconception of what’s called the “paradox of exchange”. This paradox has puzzled economists throughout the ages. Adam Smith and all the classical economists, incredibly important as their contributions were, failed when they were unable to correctly understand the concept of value theory and, thus, were never able to address this paradox of exchange. As a result, their conclusions and most of the conclusions drawn by mainstream economists are fallacious. The failed to recognize the following undeniable principle which we will analyze below:

  • When two groups or individuals engage in voluntary exchange, both groups or individuals gain.
  • When two groups or individuals engage in involuntary exchange by way of violence or the threat of violence on behalf of either group, one group or individual will benefit at the expense of the other group or individual.

To understand why the above statements are true, we must have a firm concept of value. The classical theory of value amounted to an objective value of property. Scarce material objects would be valued based on whether they were useful to society in general. A boat, it was presumed, had value for people who were trading things with people over long distances, so boats should be highly valued since everyone wanted to trade with everyone else. Boats were the transporter of other goods that were seen as valuable by society in general, so their value was deemed to be high. Something like a single fish is worth considerably less than a boat, so the value of a fish was deemed lower than the value of the boat.

The problem with this type of thinking is that it does not consider the individual who acts inside of society. An individual that values a fish may not value a boat. Another individual may value the boat and not the fish. Some individuals desire goods that are brought here on boats from remote lands, while other individuals desire goods produced locally without needing boats for transportation. All individuals value things differently.

Thus we can see where the classical economists made their error. They attempted to find the utility of a good or service based on an objective view, when, in fact, everything in economics is viewed subjectively by the person who is making decisions. This is called the subjective value theory by the Austrian economists, and we deduce that it must exist from the following statement: Human beings act because they seek to move from a less satisfactory condition to a more satisfactory condition. All action falls under this premise. An individual actor, viewing a fish more desirable than a boat, will take action to acquire a fish before they will make any attempt to acquire a boat.

Now we come to the concept of a scale of values. Since action takes place over a period of time, and since time is scarce, there can only be a certain number of actions taken in a duration of time. All action implies a renunciation of other actions. Thus, the actor must arrange the different actions that they can take in some sort of order of preference, and they will forego actions of lesser value due to time constraints. Let’s assume that my scale of values is this:

A) Go to the movies
B) Ride a horse
C) Eat a sandwich

So, I value going to the movies more than I value eating a sandwich. We must note here that my scale of values may change at any moment. It may be that after a period of 4 hours has elapsed, I’ve grown quite hungry. My scale of values is then rearranged:

A) Eat a sandwich
B) Go to the movies
C) Ride a horse

In this case, eating has taken preference over all the other actions I could take. Over time and due to different conditions in my environment, my scale of values will change based on my knowledge of the situations around me. I may not have time, for instance, towards the end of the day to ride a horse. I must forego that action for some other action that takes less time or is available to me in the proper lighting.

It is this concept that we must understand before we can look at the paradox of exchange. Each person values different things more or less when compared to other things. It is important also to note that a measurement of this value is impossible. It would be silly for a person to say I would be 3.5 times more happy if ate a sandwich than if I went to the movies. There is no numerical representation of the satisfaction of an actor; they compare one thing to another thing and decide which is better or worse for them.

Now, let us consider a simple exchange. An important logical tool in economics is the concept of Robinson Crusoe. Here is a single actor isolated on an island with only natural resources and his action. Crusoe must take action in a world devoid of tools and machines and try to survive. It helps us to isolate the behavior of the individual actor concerning things that they value and require to survive.

Let us assume that Crusoe has been spending time gathering berries. He has created some method of production where he feels he can harvest the most amount of berries for the amount of time that he allocates toward food production, and he manages to gather 2,000 berries per day. Half of them are eaten, and half of them spoil by the next day. The next day, he is left with no berries, so he cuts back the amount of time it takes to gather berries to just get 1,000 berries per day for food. Crusoe’s value scale looks something like this:

A) Eating 1,000 berries per day
B) Gathering 1,000 berries per day
C) Gathering 2,000 berries per day and saving half of them, but they spoil

Obviously, Crusoe cannot eat the berries before gathering them, so he must temporarily switch A and B so that he can gather the berries first and eat them. Ultimately, Crusoe wants to eat the berries to stay alive. Also note that case C will probably never be carried out, as Crusoe will choose to do other things with his scarce time before he wastes his time with berries that will spoil anyways.

Let’s introduce another actor. Crusoe happens to find Friday one day. Friday has spent his time on the island finding chickens and gathering eggs. He has made places to keep the chickens using wood, and he gathers about 10 eggs per day which is all he needs for food.

Friday and Crusoe realize that they can both be of benefit to each other. Crusoe had no idea that eggs existed on the island before, so his value scale now has to take that into consideration. Let’s assume now that Crusoe’s value scale for eating looks like this:

A) Eating 500 berries per day + 5 eggs
B) Eating 1,000 berries per day

He will settle for B, 1,000 berries, a day if that’s all he can gather, but now he knows that Friday has eggs. He arranges to exchange with Friday. He asks Friday how many berries it will take to trade berries for eggs. The exchange ratio that they settle on is called a price. Friday will give Crusoe 1 egg for 100 berries. So, the price of eggs in terms of berries is 100.

As we can see, in a voluntary exchange both people benefit. Friday benefited because he valued berries and eggs higher than he valued just eggs. Crusoe benefited because he also valued berries and eggs higher than just the berries he produced. This is called a double inequality of values; both parties saw more value in what they are trading for and less value in what they hold in their hands. As a result, both parties see the exchange as beneficial, and nothing is lost in the transaction. Both parties are better off than they were before the exchange happened, and both parties have increased each others access to different varieties of goods. This is called the division of labor, where people specialize in certain things then trade the goods they produce with the other specialists who produce their own goods for trade.

Remember how Crusoe was able to gather 2,000 berries instead of just 1,000? He had no use for them, and they would spoil if he gathered more. What if Crusoe happened upon two other people on the island? Let’s say one hunts and collects animal skins, and the other chops lumber and has firewood or shelter building material. Crusoe would lose 1,000 berries per day to spoilage if he had no one to trade with, but now he can have eggs and berries and trade the extra berries for clothing and wood. Any surplus that we gain in production that we don’t spend on current consumption is savings. When we save, we choose to curtail current consumption so that we can have future consumption. We can give that savings to other people in exchange, and these people value what you have saved more than they value what they’ve produced.

See how each exchange benefits all parties involved? If Crusoe was allergic to eggs, there is no serious detriment to Friday. Friday could still trade his eggs with the hunter and the woodsman, and then he could exchange those things with Crusoe to acquire berries. With voluntary exchange, everyone benefits from the labor and production of other people.

The situation where one individual or group does not benefit is a violent or involuntary exchange. This is an action that involves violence on the part of one person in the exchange. If I force someone to give me their car, it is clear that I benefited from this transaction, while the car owner did not benefit. I took something of theirs, and they lost it. In this case, someone is hurt because the car owner would have given me their car voluntarily if they thought the exchange was beneficial to them. No coercion is necessary in the case of voluntary exchange; every actor involved increases their well being in accordance with their scale of values. In other words, the exchange would have been higher in value to them than refusing to exchange. Since they were forced by violence, we cannot conclude that they valued giving me the car more than they valued continuing to possess the car.

Marx, Engels, and many other classical and modern economists do not understand this basic concept of human interaction and arrive at spurious conclusions because of their error. The theory of scales of value outlined above solves the paradox of exchange, and shows that individuals value certain things more than other things. Thus, production benefits all people and increases the well being of everyone.

Total wealth is not some fixed or static number of things; this number is constantly being increased through production and manufacturing led by the capable hands of entrepreneurs and laborers toiling away to create goods and services for the masses.

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