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Why do People Trade?

As a follow up to the last blog post where I wrote about international trade and tariffs, I want to dig in a little deeper and answer the question, Why do people trade?” It’s really simple actually.  Trading between people, businesses, and countries occurs because the other party has something you want.  That’s the basic reason why people trade.  Someone else has something that you either want or need.  Trading baseball cards is a perfect example at the most individual level.  If you live in Boston and have a player card from the New York Yankees and your best friend lives in New York and has a Boston Red Sox player’s card you two will get on the phone, have a short discussion and the trade will happen.  After all, between those two bitter rivals who would want a player from the rival team?  This is how trade works at the simplest level.

Let’s dig deeper into this concept by looking at what happens between countries.  In a previous lesson we learned about Adam Smith, the great economic thinker and moral philosopher from Scotland who lived during the 1700s championed a theory called ABSOLUTE ADVANTAGE.  In simple terms, absolute advantage refers to the ability of a person, firm, or country to produce a greater quantity of goods or services than a competitor using the same amount of resources.  So, an island country like Jamaica may be able to produce a lot more fish than a land locked country like Germany.  But Germany, because of where it is located produces a lot of coal.  Therefore, the theory of absolute advantage would say that Germany has an absolute advantage over Jamaica in coal production and Jamaica has an absolute advantage over Germany in the production of fish.