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This question already has an answer here:

The production of 'goods and services' and 'innovation' is the usual answer. I feel that doesn't really answer the question. These things can be traded for wealth but they don't generate new wealth. They essentially take wealth from others and depend on there being wealth already. At least that is how I understand it.

My question is, how is the world so much more well off than it was a century ago? (Please don't mention the industrial revolution)

How did China raise a million people out of poverty without plunging another million into poverty?

How does trade create wealth?

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marked as duplicate by luchonacho, Giskard, Adam Bailey, optimal control, Kitsune Cavalry Aug 19 '17 at 1:44

This question has been asked before and already has an answer. If those answers do not fully address your question, please ask a new question.

  • $\begingroup$ Goods are used by humans to produce goods which are used by humans to produce goods which are used by humans to produce goods.... as long as the rate at which production happens is faster than the rate at which production is destroyed (which depends on innovation, education, consumption, etc), wealth is accumulated. $\endgroup$ – luchonacho Aug 17 '17 at 20:19
  • $\begingroup$ How are apples created? I get that I can I take an apple from the grocer but if I do that he loses one, so the total amount of apples is the same. And then some are eaten. How are there still apples? Is there some magical bush that creates them out of nothing? $\endgroup$ – Giskard Aug 17 '17 at 23:29
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First we need to discuss what wealth is. Is it just the amassment of valubles? In the 16th-18th century, rulers thought so. This notion is called mercantilism. This idea was rejected by Adam Smith in book IV of The Wealth of Nations.

The current meaning of wealth is not the amount you own, but rather how much you can consume (sustainably). Formally, the definition is Total of all assets of an economic unit that generate current income or have the potential to generate future income. This is of course the same amount as the amount that you can sustainably consume. This means that we can measure wealth either as production or as consumption.

Thus, there is not just how much riches you own, but also how much you can create. Also, remember that you cannot consume money. You can only consume goods and services. Amassing riches has little value in itself. It is mainly a way (for an individual or group) to postpone consumption to some point in the future.

Thus, wealth is measured not just by the current riches you own, but also by the ability to create more riches in the future. A man with 100,000 and no income is poorer than a man with no money but with an income of 50,000 a year.

These things [...] don't generate new wealth.

But they do.

Labor

Let's look at how labor increases wealth by looking at a couple of examples:

Example 1. I work at a farm. The result of my work is some farm produce worth X. For that I am paid Y. The farmer that hired me will receive X-Y. The net wealth gain for the society is Y + (X-Y), or X.

Example 2. I work as a barber. I charge X for a haircut. The customer gets a haircut worth X. Net wealth gain for the society is X + (X-X), or X. Since the haircut is consumed immediately, the amassed riches don't increase. Note that the customer didn't lose out - to him a haircut was worth at least X or he wouldn't have gotten one. In macroeconomic terms the GDP increases by X and net savings is unaffected.

Trade

Trade increases wealth by transferring a good or a service to someone that values it higher.

Example 1: I buy a used car from a neighbour for X amount of money. I get a car that is worth Y to me (Y>=X, or I wouldn't have bought it). My neighbour gets X for a car that was worth Z to him (Z<=X, or he would have kept the car). The wealth produced is (Y-X) + (X-Z), or Y-Z, which is >= 0 because Z<=X<=Y. In GDP terms the wealth produced is X - X, or 0, because GDP only measures how much is paid.

Example 2: An electronics company imports batteries from China for 10 cents each. They sell the batteries to customers for \$3 each. The wealth increase in GDP terms is \$2:90 per battery. The wealth produced is shared by the electronics company, the shipping company, the store salesman and any others that provide services to the electronics company.

Innovation

Innovation is both the invention of new and the improvement of the existing. Actually, most innovation is small improvements in existing technology or design.

Example: I improve a machine that makes nails so that it can make twice the number of nails in the same time. This means that more nails can be produced (and thus consumed) using less labor.

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  • $\begingroup$ "A man with 100,000 and no income is poorer than a man with no money but with an income of 50,000 a year." This is definitely not true as a general statement. $\endgroup$ – Giskard Aug 18 '17 at 10:45
  • $\begingroup$ "The current meaning of wealth is not the amount you own, but rather how much you can consume " also seems weird, do you have a source for this? $\endgroup$ – Giskard Aug 18 '17 at 10:47
  • $\begingroup$ @denesp Clarified the definition of wealth and added a source. That 100,000 is poorer (=less wealthy) than 50,000 a year follows directly from the definition (provided the man expects to live longer than 2 more years). This also corresponds to how rich is used in (swedish) newspapers - it sommonly refers to people with high income. $\endgroup$ – Klas Lindbäck Aug 18 '17 at 11:08
  • $\begingroup$ Out of curiosity, who is richer: Man with 100 in the bank but no work income or man with 0 in the bank but 2/year income? They will both go on to live for 80 more years. (Should the interest rate not factor in?) $\endgroup$ – Giskard Aug 18 '17 at 15:17
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    $\begingroup$ @arooo You are confusing money and wealth. The haircut doesn't add any new money. It does add wealth (in the form of GDP) as the barber creates the haircut from nothing simply by using his skill and time. Some money is created by printing new bills and coins, but most money is created by loans. Taking a loan adds/creates money, repaying a loan removes/destroys money. $\endgroup$ – Klas Lindbäck Nov 15 '18 at 1:06

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