Praxeology - Episode 14

Translations of this material:

into Russian: Праксиология Эпизод 14 — Обмен и разделение труда. Translated in draft, editing and proof-reading required.
Submitted for translation by IrinaChernykh 18.06.2015


Who wins or loses in a voluntary exchange? How do we know that both parties benefit from a voluntary exchange?

Hi guys, Praxgirl here.

In our last lesson we covered the concept of the formation of capital. We learned that man must engage in a process of saving in order to fuel projects that will help him raise his standard of living.

Praxeology’s conclusions hold true for all human action, but up until now our lessons have been restricted to talking about individuals in isolation. The exchange, or cost of acting, have only been with themselves.

In this lesson we will begin to examine what happens under conditions of interaction between two or more individuals.


As we have seen in previous lessons, action is always an exchange. For an individual, any and all actions involve forgoing what he could have done for what he actually does. In the case of two or more individuals engaging in an exchange, the same principles apply. Let’s see an example that defines the different types of exchange:

<script> <put list of types of exchanges on the screen>

As you can see, in the involuntary exchange, where the stranger pulled a knife on me, only he benefited. He used coercion because without it the exchange would not have happened. I was not willing to exchange my scarf for his apple because I did not think the exchange would have benefited me. My choice was to cooperate or not to cooperate.

In the case of the voluntary exchange, we saw that it only took place because I valued the stranger’s jacket more than my scarf, and he valued my scarf more than his jacket. Another way to look at it, I could say that on my value scale, the jacket was in a higher order than the scarf. Likewise, on the stranger’s value scale the scarf was higher than the jacket. This reverse valuation of goods must be present for any voluntary exchange to take place, otherwise no exchange would occur.

Thus we can say that in a voluntary exchange each participant must logically benefit by the transaction. A voluntary exchange means a win-win situation. It is this form of mutual concerted action between two or more individuals, for the attainment of definite ends, that forms the concept of a society.


We can also deduce from the fact of two parties participating in a voluntary exchange that both parties must have two different goods to offer. If the stranger had an identical scarf to mine already, there would be no opportunity for an exchange to take place. Likewise, even if we both produced jackets and scarves, then there would at least have to be a difference in the amount of stock of jackets and scarves between us for there to be an opportunity to exchange. What this means is that we both must have specialized more in the production of one good over the other. Therefore exchange implies specialization of production, or division of la­bor.

The phenomenon of division of labor is a conscious response from individuals who recognize, through reason, the benefits of exchange with their fellow men. We’re born into a world where nature puts us in a state of inequality. Some men have a natural ability to perform tasks better than others. John might be better than Paul in growing wheat, and Paul might be better than John in producing cow milk. Or, John and Paul may simply be born into different geographical locations where the serviceability of the land differs.

Because of these differences among the natural abilities of men and natural characteristics of the various places on earth, we observe that individuals are more productive when they specialize in performing a certain kind of task and exchanging with others, rather than performing isolated tasks as self-sufficient individuals. People divide and specialize their labor and then trade.

Clearly, it’s far more efficient for a group of individuals to each dedicate their time and effort to specializing in only producing one good, rather than attempting to produce various goods. If John is better than Paul in farming and Paul is better than John in producing cow milk, then both will be better off if John completely focuses on farming and Paul completely focuses on producing cow milk and they engage in trading their respective products.


There are situations where one individual can far surpass a potential trading partner in all productivity. If we consider that Paul were better at both farming and producing cow milk than John, the question might be asked, why would Paul engage in an exchange with John?

Suppose that in a day, Paul makes 12 bags of wheat over 12 hours, and milks 6 cows in the remaining 12 hours. John, who is not as efficient only manages to produce 6 bags of wheat in 12 hours and milk 2 cows in the remaining 12 hours.

If Paul and John both work at this pace in isolation, their total production is 18 bags of wheat and 8 cows milked. If we consider both individuals in isolation, then we can say that the cost of each bag of wheat for Paul is 2 units of milk. Likewise for John, the opportunity cost, the cost he forgoes in terms of milk to make a 3 bags of wheat is ⅓ of a unit of milk.

Paul, the superior producer in both products, could still see an opportunity to increase his productivity through trade. John can switch his production and focus on what he is best at, wheat, and stops his production of milk completely. He dedicates 24 hours a day to producing wheat in order to trade with Paul. This allows Paul to slow his production of wheat and dedicate more time into producing milk in the anticipation of trade with John.

If Paul and John exchange, Paul may give John 2 units of milk in exchange for John’s 5 bags of wheat. That leaves Paul with 13 bags of wheat and 6 units of milk, while John now has 7 bags of wheat and 2 units of milk.

Let’s total up the production between Paul and John. Before cooperation: 18 bags of wheat and 8 units of milk. After cooperation: 20 bags of wheat and 8 units of milk. So, what have they gained in this example? Exactly 2 more bags of wheat. One more bag of wheat for Paul and one more for John. No technology increased, no capital was added, it was merely that two individuals applied their reasoning to recognize that exchange would benefit both of them.

This important principle-that exchange may beneficially take place even when one party is superior in both lines of produc­tion, is fundamental to understanding the benefits of free voluntary trade and how a society prospers.

If one party is superior than the other in producing both the goods, then it should focus on producing the good at which it has maximum advantage over the other party. A surgeon is better than his assistant in both surgery and cleaning instruments, but because he is much better in surgery than in cleaning instruments, it’s beneficial for him to hire the assistant to take care of the instruments and fully devote himself to perform surgeries. This is known as the law of association.


As we covered earlier, the network of voluntary interpersonal exchanges forms a so­ciety; it also forms a pattern of interrelations known as the market. This network opens to man the opportunity to engage in production merely for the purposes of exchanging with another individual; to produce “for a market”, rather than for himself.

We also learned that exchanges occur because of the innate inequalities between men and the land. What should also become apparent is that exchange and the division of labor pushes men further and further into specialization. It intensifies these innate inequalities. The division of labor causes some places to be cities, and other places to remain rural farm land. It causes men to become specialists in a certain vocation.

We can use our theory of exchange to understand our world around us. Today, the results of millennia worth of the division of labor can be easily pointed out. Where once most doctors were general practitioners, we now have very specialized doctors who treat only one kind of disease. Where once a shoemaker made only one kind of shoe, we have companies that are dedicated only to making a specific type of shoe for a specific sport. Every step forward on the road toward a market that satisfies the most amount of desires requires specialized, more refined, and more productive technology, and this in turn requires a further specialization of tasks. When we meet someone new we generally ask them “what do you do?” This is an obvious effect of the increased specialization of labor in our society. In primitive times, the answer would have been most likely the same for every individual, but today we bask in the variety of jobs open to us.

The market benefits everyone, including those who are inferior in all possible modes of production. Marvelously, this happens regardless of men’s motives. John may absolutely detest Paul for who he is, but because he recognizes that he is better off if he engages in exchange, he has an incentive to cooperate and show respect to his fellow man. Acting in a state of peace through interpersonal relationships offers a better opportunity for men to recognize their shared common values and become friends.

The concepts of exchange, division of labor, and the law of association are absolutely essential to understanding why cooperation and peace, rather than isolation or violence lead to wealth and prosperity.

I’ll see you guys in the next lesson.