Wednesday, July 22, 2009

Why does a Perfect Trading turn South ?


I was truly inspired by an article posted by Champdog that explain how trading can create values ie. 1 + 1 >= 3. The story goes like this;
At first the Farmer can make 4 meats in 4 hours and 16 potatoes in another 4 hours. The Rancher can make 24 meats and 48 potatoes like wise.

Then when they started trading, Farmer concentrates on making 32 potatoes in 8 hours while Rancher makes 18 meats in 6 hours and 12 potatoes in the rest of 2 hours. Farmer gives Rancher 15 potatoes, Rancher give Farmer 5 meats.

After trading, Farmer has 5 meats and 17 potatoes vs previously 4 and 16. Now Farmer has more ! Rancher has 13 meats and 27 potatoes, Rancher has even more than Farmer's more!
If this is confusing, please read the full article here.

Well, indeed it was how trading world could have started. It is indeed perfect for both parties as well. Then why do we have so much problem today ? What has happened since then ? Let's continue the story ...

Farmer uses 4 hours to make 4 meats, so Farmer is making 1 meat per hour. Like wise, Farmer's proficiency on making 1 potatoe is 1/4 hour

Rancher on the other hand use 1/3 hour to make 1 meat and 1/6 hour to make 1 potato.

So when Farmer gives 15 potatoes to the Rancher, the Farmer is giving away 4 1/4 ... 3 3/4 hours of his work away. Rancher on the other hand is exchanging it with 1 2/3 hours = 5 meats.

Things are still ok up to this point. Rancher out performs Farmer in all angles, Rancher makes more items relatively and due to his talent, he can use less time to make more things. Farmer gets more anyway during the trade, Farmer shouldn't complain neither. As long as they are mutually respective, this is still an honor deal.

Now, what happen when we assign value into effort ? As in salary paying as per hours worked, as per over time payment etc. Lets say 1 hour is equivalent to $1. And to be fair, both of Farmer and the Rancher are valued the same.

During the exchange, Farmer is giving away $4.25 ... $3.75 of his potatoes while Rancher is giving away $1.33 of meats. Rancher is buying $4.25 ... $3.75 with $1.33

Remember Farmer takes 1 hour to make 1 meat ? So Farmer's meat is $1. Rancher's meat is $0.33. Since both of them are working together, they will determine the market price of meat should be the average between the 2 ie. (1 + 0.33) / 2 = $0.665 = meat's market price.

Like wise potatoe's average market price is $0.21

What does the Farmer have after the trades ? 5 meats and 17 potatoes, equivalent to $6.87
Rancher has 13 meats and 27 potatoes or a market value of $14.315

Farmer started with $8 and ends with a market value less than $8.
Rancher also started with $8 but ends with a market value more than $8.

This Capitalism. This is why the Rich gets Richer and the Poor gest Poorer.

Remember what the Rancher said? "Its Magic!" ( in the original post )

4 comments:

ChampDog said...

This example is really awesome! This finally explains why the rich is richer and poor is poorer. Relatively, the poor feel rich too because they enjoy more?

Interestingly, so now what shall the poor do? Helpless?

Michael Tsen said...

not really helpless, in this story alone, the only problem is when we assign $ to the hour, as in paying salary for 8 hour job. As soon as you apply $ to the item, ie the meat and the potatoes, the whole thing is perfect again, ie. pay for performance.

Today's problem is because 90% of world population is earning a salary. Imagine if 100% of world population is producing meat and potatoes, we WILL BE perfect.

In another words, everyone needs to do what he is good at, produce a lot of that, get paid by performance or achievements and exchange his output with what he needs.

This is actually already proven and happening when China sign up bi-lateral trades with South East Asia and Brazil etc.

As far as I can see, as long as USA does NOT regain back world power, the world's finance may actually be improved. Opps, I mean as long as USA will lose its world power to China :)

WebSearchers said...

Liked your article very much...thanx for sharing.By the way
"So when Farmer gives 15 potatoes to the Rancher, the Farmer is giving away 4 1/4 hours of his work away"...
isn't it supposed to be 3 3/4 instead of 4 1/4??

Michael Tsen said...

you are right, its 3 3/4

In order to show my appreciation to your correction, please contact/email me to get a complimentary gift : crystal ball.