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When is trade mutually beneficial?

September 15, 2011

The presumption among economists is that trades are generally beneficial for both parties. Each person trading will only do so if they think that they will be better off after the trade. I find it helpful to categorize objections to trade so that it is clear to see under what circumstances trade is harmful and when it is beneficial.

There are three main scenarios when trade is not mutually beneficial:
1. A trader does not get what they expect.
2. A trader is forced into an agreement.
3. The trade creates negative externalities.

Information and Expectations
When people trade, they imagine a future with and without the trade and evaluate those hypothetical worlds. For example, when you are considering buying a candy bar, you imagine a future of eating the candy bar and compare it with an imaginary future without the candy bar. Those two futures are compared and you select the one which is more appealing. The correctness of the decision you make depends on the accuracy of your expectation of the future.

People’s expectations can be incorrect because of fraud, they could be ignorant of what they will get from the trade, or they could simply not enjoy the result of the trade as much as they thought they would. Limited information is a permanent feature of human experience, and so is not a market failure, per se, but it can cause trades to be harmful.

If someone says that information is causing trades to by systematically harmful, they must either claim that the harm is greater than the total benefit of having the market at all, or propose an alternative institution that improves the flow of information. Often the proposed replacement for markets do not solve in the information problem, and so do not improve outcomes.

Coercion
Forced exchange is not really trade, but I include it because sometimes people consider it a sort of trade. If a trade helped someone, they would not need to be forced to do it. Some examples indlude slavery, colonial resource extraction, and eminent domain.

Externalities
Negative externalities occur when any trade between two people hurts a third person. Economists usually have a threshold before they consider something an externality, since every trade affects someone else at least a little. The classic example of a negative externality is pollution. When someone produces something that generates pollution, they and their customers only suffer a fraction of the negative side effects from the pollution. Trades with positive externalities are still mutually beneficial.

Mike Munger has coined a term, “euvoluntary“, which is the type of trade that everyone agrees is beneficial.

From Munger’s blog, Euvoluntary Exchange:
An exchange is “Euvoluntary” if:
(1) conventional ownership
(2) conventional capacity to buy/sell
(3) absence of regret
(4) no uncompensated externalities
(5) neither party coerced by human agency
(6) neither party coerced by circumstance; the disparity in BATNAs is not “too large” (opportunity cost not too low)

For more on Euvoluntary exchange, listen to this podcast.

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3 Comments leave one →
  1. September 16, 2011 3:50 pm

    “Often the proposed replacement for markets do not solve in the information problem any better than the original market, and so do not improve outcomes.” [citation needed]

    Not that I don’t believe you. I’m just interested in hearing an example.

    Also, forgive me if I’ve asked you this before (if I did, I forget your answer): How do you define force? Is threatening a person forcing them? What about brainwashing?

    • September 16, 2011 6:45 pm

      An example would be occupational licensing. Frequently information is cited as a justification, but many occupational licensing requirements and procedures don’t actually provide any good information to customers about which producers are good.

      Threats of force are basically the same as force in affecting choice. If you can convince someone that you will use force against them, you can get the same compliance as if you actually do. Brainwashing would be more under the category of information, depending on how it was done. Maybe a little of both.

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