What is “Principle 5: Trade can Make Everyone Better Off”?
“Principle 5: Trade can make everyone better off” is the fifth principle out of the ten principles that the eminent macroeconomist N. Gregory Mankiw has given us in his book “Principles of Economics.” The principle helps us to understand how people interact with each other in an economy. It explains to us how we all are better off by trading with each other rather than doing all the activities ourselves.
How does Trade make Everyone Better Off?
A famous saying goes, “Jack of all trades, master of none.” We cannot specialize in any economic activity if we try to do all the work by ourselves. We need to entrust others with work in an economy. This way we will enjoy a larger variety of goods and services of better quality and at lower prices.
When we take into account all the market participants at an individual level, we decipher that everyone has some special skills or expertise. Some may be good at manufacturing a particular product; some may be good at providing some service, and some may have special artistic or creative skills. It is in the best interest of each and every person to do what he is best at doing. Also, there are various economic activities that require special technical knowledge and training. It is not possible for everyone to have that in each and every field.
For example, it is best for an electrician to offer his services in his domain and trade with others for everything else he wants. If he tries to repair his own house, sew his own clothes, grow his own agricultural produce, etc., he will not be able to do anything with ease and perfection. Neither will he have time to offer his basic services as an electrician. Thus, he will be worse off rather than saving any extra money by doing each task by himself.
Therefore, everyone will gain by doing only the activity that they perform better than the others. They should engage in trading the rest of the items with others. This will help them to be perfect in one field and reap the benefits of economies of scale and scope. When a person repeatedly makes some product or renders a service, he becomes specialized in it. He can soon do it better, faster, and in a more cost-efficient manner than the others. This is the benefit of achieving economies of scale which can help him to earn more. Similarly, a person can produce a few related goods or render a few related services and can be better off because of economies of scope.
He can trade with others and buy the rest of the things and services that he requires for his living. This way, he will be purchasing better-quality goods at a lower price than what he would get If he made them himself. This is the reason why “Principle 5: Trade can make everyone better off” holds.
Trade Between Countries
The above phenomenon is not just limited to individuals. It applies to international trade as well. Every country has specific natural and technical resources that suit a particular economic activity. Some may have an agricultural advantage over others, while some countries may specialize in technical skills and expertise.
For example, China is the world leader in manufacturing a few products, such as lighting. Also, it supplies technological products across the world at prices that no one else can match. Hence, any country will be better off importing these products from China rather than making them on their own. Instead, a country can focus on optimum utilization of its available resources to produce other better-quality products at lower prices which other countries will want to trade with it.
Hence, we see that countries are also better off when they do what they specialize in. They can provide those particular goods and services to other countries at a lower cost. Also, the quality will be excellent. They can trade and purchase goods and services from other countries according to their respective skills and specialization. This way, the trade will make everyone better off in the entire world.
“Principle 5: Trade can make everyone better off” is apt at an individual level due to the benefits of specialization, economies of scale, and scope. At the international level, the present era of globalization has made international trade easy and doable for all.
The physical borders of countries are barriers for people no more, and all can engage in international trade. This calls for specialization in a few areas and excelling in them. It also helps us to achieve economies of scale and scope. The end result is access to a large variety of goods and services at affordable prices.
- Principle 1: People face Trade-offs
- Principle 6: Markets are Usually a Good Way to Organize Economic Activity
- International Trade – Types, Importance, Advantages And Disadvantages
- Comparative Advantage
- Principle 4: People Respond to Incentives
- Pareto Principle – Meaning, History, 80/20 Rule and Example