Russ and I will both speak this weekend to high-school teachers about trade. One of the points I hope that Russ or I get the opportunity to make comes from a simple extension of the standard explanation – the “2 X 2” explanation – of the principle of comparative advantage.
I’ll not review that explanation in this post. (You can find an eloquent and supremely clear explanation here.) But here’s the point: the principle of comparative advantage explains why, if one trading partner becomes more efficient at producing whatever good or service she specializes in producing, her trading partners’ comparative advantages in whatever goods and services they specialize in producing intensify even without any change in the productive abilities of these trading partners.
Here’s what I mean. Suppose that, until today, the maximum number of fish Suzy could produce each month was 200. Suppose also that the maximum number of bananas she could produce each month was 100. [That is, if Suzy did nothing but produce bananas, she’d produce 100 bananas each month (and no fish); if, in contrast, she does nothing but fish, she catches 200 fish each month (but gathers no bananas). Similarly — with the numbers 50 bananas and 50 fish — for Sam.]
The corresponding numbers for Sam are 50 fish and 50 bananas. Suzy has a comparative advantage in producing fish while Sam has a comparative advantage in producing bananas. The reason is that each fish costs Suzy 0.5 bananas to produce while each fish costs Sam 1 banana to produce, and each banana costs Suzy 2 fish to produce while each banana costs Sam 1 banana to produce. It’s easy to see that Suzy will gain by agreeing to buy bananas from Sam at any price lower than 2 fish per banana. Likewise, Sam will gain by agreeing to sell bananas to Suzy at any price higher than 1 fish per banana. Mutually advantageous gains from trade clearly are possible.
This explanation is standard, yet still important and exciting, stuff.
BUT – suppose that Suzy’s fishing skills improve. She’s now able to produce a maximum of (say) 300 fish (rather than 200 fish) per month. Nothing happens to Sam’s skills.
Suzy’s clearly better off. But so, too – at least potentially – is Sam. Before Suzy’s skill-enhancement, Sam could produce bananas at half the cost that Suzy incurred to produce bananas. (Remember, each banana cost Sam 1 fish to produce, while each banana had cost Suzy 2 fish.) Now, however, after Suzy becomes a better fisherwoman, Sam suddenly finds himself able to produce bananas at one-third (rather than one-half) of Suzy’s cost of producing bananas.
Put differently, just as Suzy’s enhancement of her skills increases her comparative advantage over Sam at catching fish, this very same enhancement in Suzy’s skills increases Sam’s comparative advantage over Suzy at gathering bananas.
Sam now has at least the potential to sell his bananas to Suzy at a higher price (i.e., more fish per banana) – or, what is to say the same thing, to persuade Suzy to lower the price she charges for her fish.
