Trade, or barter, or exchange of one commodity for another, is one of the foundations of modern life. Most transactions today are carried out using money. Money is exchanged for something – fruits, a home, a person’s time, etc. We hardly see transactions in which one item is traded for another. Money acts as a convenient medium of exchange.
Consider the situation where person A sells a house to person B, for Rs. 50 lakhs. What is the “real” value of the house? Since person A sold it for Rs. 50 lakhs, he must think it is worth less than that. From person B’s point of view, it is worth more. Is one of them wrong? By this reasoning, the trade, and for that matter, any trade, will not happen, assuming that all people are “rational”, and can assess value to a good extent. So what’s happening in the world today? In every trade, both parties think they are getting a good bargain. Is one party making a mistake in every trade?
Not necessarily.
The above analysis refers to a fixed “real” value of a good. This misses an important aspect of value – value is asymmetric. This asymmetry of value is at the heart of trade. Essentially, this means that trade need not be a zero sum game. Both parties can gain from a transaction. In the above example, person A wants the money more than the house, and vice-versa for person B. By carrying out the trade, both are better off. Every time you buy bread at the store, the shopkeeper is better off with the money you give him, than the loaf of bread, and you are better off with the loaf.
There are some more subtleties involved. Given that both parties are better off, there is some “surplus” in the trade. Dividing this surplus between the two parties is the subject of bargaining. Also, not all trades result in both parties being better off. In some trades, one of the parties may be worse off. In fact, both may be worse off in some cases. Think about trading blows.
Thoughts for the Long Run 