The Magic of Markets: Trade Creates Wealth

Introduction:

Trade is the voluntary exchange of goods and services. People engaging in trade must be willing to bear a cost (give up something). Therefore, we know that people will only participate voluntarily when they expect to gain from the exchange. If even one of the trading partners believes he cannot gain, the exchange will not take place.

Video Demonstration:

Concepts:

Trade
Voluntary exchange
Costs
Benefits
Property Rights

Economic Content Standards:

Standard 5: Voluntary Exchange

Voluntary exchange occurs only when all participating parties expect to gain. This is true for trade among individuals or organizations within a nation, and among individuals or organizations in different nations.

• Exchange is trading goods and services with people for other goods and services or money.
• People voluntarily exchange goods and services because they expect to be better off after the exchange.
• When people buy something, they value it more than it costs them; when people sell something, they value it less than the payment they receive.

Lesson Description:

This lesson involves students in a trading simulation designed to illustrate a complex marketplace in which goods and services are traded. Students use this experience to investigate the conditions that encourage or discourage trade among individuals.

Time Required:

One class period.

Materials:

A large number of small, easy to exchange items – such as miniature candy bars, small boxes of raisins, inexpensive small toys, packages of sticky notes, pencils, stickers, library passes, hall passes, answers to a quiz, etc., and enough small brown bags for each student.

Procedure:

1. Before beginning the simulation, place the trading articles, unequally, in brown paper bags and seal them. Divide the bags into groups of about 5 or 6, depending on class size, and mark all bags in each group with the same colored dot or letter. Mix all the bags together in a large box or trash bag.

2. Explain to students that today they have an opportunity to participate in a trading activity. The purpose of the activity is to explore why people trade.

3. Ask, “Why do people trade?” Record some student responses on the board and indicate that these responses are hypotheses. Explain to the class that today’s activity will provide information and experience with which to test the hypotheses.

4. Describe the following situation to the class. Imagine that a teenage music lover walks into a music store, picks out the latest CD by his favorite artist and pays the owner $18. Who gained and who lost in this transaction?
(Both people gained in the trade. The music lover gave up something of lesser value, $18, to get something of more value, the CD. The owner gave up something of lesser value, the CD, to get something of more value, $18. Both the music lover and owner ended up with something of more value to them. Hence, they both gain.)

5. Announce to students that you are going to give them bags, which they will then own, and ask them not to open the bags until told to do so. Randomly distribute the bags and emphasize” “Whatever is in the bag is yours.”

6. Ask students to open their bags and look at the object WITHOUT removing it from the bag or showing it to anyone else. Direct students to rate their satisfaction with the bags using a show of hands and a 1-5 rating system in which 5 is high and 1 is low.
(Ask for a show of hands for each rating – 1, 2, 3, etc., and record tally on the board or overhead transparency. Caution: Ensure that every student votes in each round.)

7. Tell students they may now take the objects out of the bags. Direct them to move to designated locations around the room according to the symbol (or color) on their bags. Remind students that “whatever is in the bag is yours,” and that they may trade or not, open the package or not, trade parts or all or nothing. After several minutes, direct students to return to their seats. Repeat the 1-5 evaluation by show of hands, reminding students to rate what they now have in their possession, and reminding them that they must rate their bags again whether they traded or not. (Note that students may change their ratings even if they don’t trade. Be sure that every student votes, even if he hasn’t traded or changed his satisfaction rating. Record the tally on the board with a different colored marker than the first tally.)

8. Conduct one or more additional trading rounds, combining groups, etc. with the last round involving all class members. In each successive round, increase the size of the trading area by combining groups. (For example, blues and greens may trade, yellows and reds may trade, etc.) In the last round allow students to trade with anyone in the class. Do a “satisfaction” rating after each round and record the tally.

9. While the students are trading, or after all trading is completed, calculate the total “satisfaction points” for each round. Record the total below each tally.

Debriefing Questions:

1. How many people made trades?
   • Ask several traders what they traded and why.
   • Follow the students’ explanations by asking how they felt after the trade. (Most students will be “happier,” and will feel that they got the best end of the deal.)
   • Find the student who was the other party to the exchange and ask why he/she traded and how he/she felt after the trade. (Most of the trading partners will also be “happier.” If a student does not report feeling better off, find out why. This is a chance to emphasize that costs occur in the future and that sometimes we make mistakes in anticipating that we’ll benefit more than we actually do. See debriefing questions on cost below.) (Most of the students will have made trades; however, there will be a few who were either satisfied with what they had and did not trade, or who had something that no one would trade to obtain.)
2. Go back to some of the students who discussed their trades in response to question #1 and ask what it cost to make the exchange. (Students had to give up some or all of what was in their possession in order to make the exchange. Emphasize the definition of opportunity cost as the foregone alternative. Emphasize that costs exist because of scarcity.)
3. Did anyone trade more than once? Why? Did anyone not trade? Why?
   (Several people should have made numerous trades. Elicit articulation of the fact that the trades continued only as long as the traders perceived they would continue to benefit. Even the person making multiple trades stopped when anticipated no gain from the next trade. Then call on some of the students who did not trade at all, and ask why they didn’t. Expect to hear either that the person saw nothing he valued more than what he had originally and wouldn’t trade, or that no one else valued what was originally in the bag, so the person couldn’t trade. Emphasize, again, that voluntary trade is based on the mutual perception of benefit.)
4. Point to the tally of satisfaction points on the board as empirical evidence of “increased wealth.”
   • How did wealth increase when nothing new was added? (There was more wealth because through voluntary trade, the articles in the bag went from people who valued them less to people who valued them more, increasing the wealth of both trading partners.)
   • What generalizations might we make about trade based on how the tally changed from round to round? (Expect a variety of answers, including: The value of things is subjective; some people value a particular thing more than other people do.[Some students may comment that subjective valuations change just by having something to compare to. Some people changed the ratings of their objects after seeing what other people had.] Having more trading partners was better than having few. More trades meant more satisfaction points; more trade means more wealth. Etc.)
5. Why do people trade?
   (People trade to get something of more value by giving up something of less value.)
   • Did trading behavior confirm or contradict the hypotheses we listed at the beginning of the activity? (Often the initial responses are “to get something they don’t have, or to take advantage or sucker someone.” Students should see that trade only takes place when both parties expect to gain. Sometimes, however, the gain is not material as when students trade to make someone else feel good.)
6. Was it possible to trade without bearing a cost? Why? (No. Because of scarcity, we cannot have everything we want. There is always a trade-off.)
   • What was the cost and what was the benefit of each trade? (What was traded away was the cost of the trade. What was received was the benefit.).
7. What were the necessary conditions for wealth-creating trade to take place? (Emphasize the importance of 2 “rules of the game” (institutions):
   • property rights – remind students that you emphasized that what was in the bags was theirs, and
   • voluntary exchange – no one was forced to make an exchange.
   • What would have happened if you had been forced to trade? (Students should recognize that they would not have experienced the same overall increase in satisfaction.)

   Encourage students to look for the role of institutions as we continue our study of economics.

8. Does the creation of wealth make everyone happy? (Definitely not. Students who had little to trade may not have been pleased. Students who couldn’t find what they wanted may have been dissatisfied. Students who traded and then realized they missed a better trade may have been unhappy. Students who either underestimated the costs of a trade or overestimated its benefits — or both — may have been unhappy. Emphasize that economists don’t say that trade make people happy; they argue that it creates wealth. Also note that saying “trade creates wealth” doesn’t mean that every individual person will be wealthier. Economists merely maintain that trade creates wealth overall and that trade will continue if people anticipate that they will be better off after the trade than if they do not trade at all.)
9. If we were to observe twenty people buying items at an outdoor Farmers market, what could we conclude about their gains and losses? Their wealth?
   (Each transaction takes place because both parties expect to gain. If one party does not expect to gain, there is no transaction and we would have nothing to observe! Therefore, we observe people trading money for we can conclude their wealth and the wealth of the grocery store has increased.)

The Magic Of Markets combines procedures used in “Why Do People Trade,” Master Curriculum Guide In Economics International Trade, by Donald R. Wentworth and Kenneth E. Leonard (Copyright 1988 by the National Council on Economic Education, 1140 Avenue of the Americas, New York, NY 10036. All rights reserved. No part of the Master Curriculum Guide In Economics International Trade materials may be kept in an information storage or retrieval system, transmitted, or reproduced in any form or by any means without permission in writing from the National Council. Used with permission.) Questioning strategies and procedures developed by Kathy Ratté and Kenneth Leonard for the Foundation for Teaching Economics.