A Note on Comparative Advantage

by Don Boudreaux on September 15, 2009

in The Economy, Trade

Moggio, commenting on this post, asks for “a text that explains that the principle of comparative advantage still holds under ‘non standard’ assumptions.”

This principle is not an esoteric possibility, identified by clever economists, in search of applications in reality; it’s not something that requires any unusual set of conditions in order to operate.  It’s operation is nearly universal.  It permeates our reality. All that it requires is that, as between any two potential trading partners, the cost to one of them of producing (or, more generally, of trading away) at least some units of good X is less than is the cost to the other trading party of doing the same.

Critical to the point of comparative-advantage explanations is the recognition that costs are reckoned as values forgone by producing and trading.

I can walk faster than my secretary.  Yet on those occasions when I need a document hand delivered quickly somewhere on campus, I send her to deliver it.  The reason is that, although the amount of time that it would take me to deliver the document and to return to the office is less than the amount of time that my secretary requires to do the same task, the value of my time is greater than the value of her time.  That is, the value of the output that I would forgo producing were I to deliver the document myself is greater than is the value of the output that she forgoes producing when she delivers the document.

So I have a comparative disadvantage, relative to my secretary, at hand-delivering documents — meaning she has a comparative advantage over me at this task.  Because she can perform this valuable task at a cost lower than I can perform it, we both gain — I by paying her to relieve me of the cost of performing this task, and she by being paid an amount sufficient to compensate her for performing it.

Nothing in this account depends upon ‘perfect competition,’ ‘perfect’ knowledge, or anything particularly special.  The facts of reality that create this particular instance of comparative advantage between my secretary and me are ubiquitous; they create countless instances of comparative advantage across each office suite, across each town, across each country, and across the globe.

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Anonymous September 15, 2009 at 2:17 pm

It’s helpful also to think of “money” as “resources” in this context. Many people see money in the abstract, so paying your secretary to carry the document feels detached from the output you create at the same time. If instead you use your time to create 10 widgets and your secretary will happily deliver your document for 5 widgets, the net gain of 5 widgets is clear.

Curious September 15, 2009 at 6:57 pm

Excellent! Thanks.

Anonymous September 15, 2009 at 2:32 pm

Don, perhaps I am being a bit reactionary, but I think you do yourself and the ideas you champion disservice by couching them in what many will perceive to be chauvinist terms.

Two bitter pills are harder to swallow than one, and I see no reason not to sugar coat the exposition.

Cheers

Anonymous September 15, 2009 at 2:37 pm

What’s chauvanist about what he said?

BoscoH September 15, 2009 at 3:16 pm

Comparative advantage of idea presentation. You can use the high value male boss, low value female secretary, menial task example and drag in all the feminist critique costs. Or you could find another example that doesn’t drag that baggage in.

What I dislike most about the feminist critique is that it takes any particular example, like Don’s and extrapolates that example as a dominant pattern of systemic injustice. We see similar rhetoric invoked in the health care debate, where an example of someone who couldn’t navigate COBRA waters turns into a mandate to nationalize 1/6 of the economy. But it’s a battle you can’t win in front of the easily deluded.

Anonymous September 15, 2009 at 3:22 pm

Or, conversely, someone who conflates a very specific premium-financed public plan (like Don’s very specific example of a relatively slower female secretary) with the nationalization of the entire industry (much like Don’s specific example is mistakenly conflated with a general statement about women). You’re right – the easily deluded are hard to engage.

Anonymous September 15, 2009 at 3:44 pm

“premium-financed public plan”

How sure are you about that? What exactly then is costing “$900 billion over a decade” (from here: http://www.bloomberg.com/apps/news?pid=20601087&sid=auZYSu9ljFUs) Anyway, after the experience of Amtrak, US Mail etc. surely you must have doubts that such a plan can be completely funded through voluntary premiums.

Anonymous September 15, 2009 at 3:49 pm

My understanding is we don’t have a bill the details the finance but we will have it very soon.

But I didn’t mention any specific plan. I’m not talking about an expansion of subsidized plans, like Medicaid. I’m talking about the principle that you can’t talk about anything reasonable without someone countering by talking about a nationalized industry that nobody is proposing or considering.

Sorta like raising feminism issues when the simple fact is Don can walk faster than his secretary.

BoscoH September 15, 2009 at 3:47 pm

Touché! Except your talking about someone who claims there is some very specific public plan under consideration (which there probably is, somewhere) when the overall politics as expressed by centrist Republican Olympia Snowe are that in the more deliberative portion of Congress, there isn’t sufficient support to pass *any* public option plan.

Ok, instead of this little pissing skirmish, I’ll try to couch this with a counterexample. People who read the Reason Hit & Run blog know that Radley Balko dishes up a continual stream of egregious police and prosecutorial misbehavior. Yet I think the general experience there is to be cautious about placing trust in police rather than to think the whole concept of having police is a dismal failure. Short of SWAT teams anyway… It is possible to argue against injustice and for change without jumping the shark 24/7.

Anonymous September 15, 2009 at 3:23 pm

Back to comparative advantage…

Don – do you know of anyone that has done work with endogenous production technology and comparative advantage? Scale economies seems to be one prominent example of this, but are there others?

vincent September 15, 2009 at 3:48 pm

Isn’t Krugman and Helpman’s work on situations where free trade isn’t optimal a classic example of endogenous production technology and strategic trade policy? There’s a big literature on the exceptions to free trade. However, as Krugman and others have noted, the exceptions usually require a perfectly informed and benevolent government not subject to public choice pressures.

Anonymous September 15, 2009 at 3:59 pm

Right – and what Krugman and Helpman primarily talk about are scale economies – creating comparative advantage. I’m not sure they require a perfectly informed government any more than comparative advantage requires a perfectly informed market. But the point is there are huge practical obstacles – and insofar as it is a reasonable path, it’s probably most reasonable for pre-industrial economies and infant industries.

I was thinking more in terms of the endogenous atrophying of productive technology, which Prestowitz seemed to be alluding to (badly, granted).

Tim of Angle September 15, 2009 at 5:06 pm

I think it’s just that you don’t want to walk that far. Not that there’s anything wrong with that.

Anonymous September 15, 2009 at 5:17 pm

danielkuehn wrote:

I’m talking about the principle that you can’t talk about anything reasonable without someone countering by talking about a nationalized industry that nobody is proposing or considering.

This is an attempt to smuggle in two premises: 1) the premise that any plan that proposes anything less than total nationalization is “reasonable” and therefore may be considered, and: 2) the premise that if Obama denies that what he is doing is “nationalization”, then what he is doing is not nationalization, regardless of the specifics of the 1000+ page bill being debated in the House and regardless of the actual likely consequences of the proposed legislation.

Both premises are false.

Partial enslavement is not made “reasonable” by the fact that it is less onerous than total enslavement. The fact is, there is nothing whatsoever “reasonable” about the use of physical force to extract earnings from one man for purposes of providing unearned benefits to another — in reason, nothing justifies it. No amount of need on the part of one man endows him with a right to another man’s earnings.

Nor does Obama’s repeated claim that he is only trying to “foster competition and choice” make it so. The man is a bald-faced liar. Go here for a list of the 7 major lies in his latest healthcare speech:

http://www.realclearpolitics.com/articles/2009/09/14/obamas_dissolving_credibility_98294.html

Obama is a typical power-lusting, statist looter with a single talent: the ability to pitch socialism as if the events of the 20th century never took place — as if socialism in all its forms did not starve millions to death in countries that practiced it consistently and impoverished millions more in countries that practiced it partially. It is his singular ability to lie with a straight face — to tell that whopper while looking and sounding completely sincere — that has made him the darling of all those parasites on the left who wish to exist without effort.

louh September 15, 2009 at 6:18 pm

It’s a new and improved socialism, haven’t you heard ? American style, that is fully aware of the pitfalls that have led to extreme hardships in the past. Haven’t you seen Pres. Obama smile, come on he’s just like the turkey farmer feed, feed, feed, and then Thanksgiving Day.

Taylor September 15, 2009 at 6:36 pm

Boudreaux,

An even better example of comparative advantage is:

the entire division of labor in general.

There is a division of labor for a number of reasons but one of the primary reasons is that most people don’t do everything well, or do everything more efficiently than anyone else does, so there are gains to be made by specializing their trade or skill and concentrating on one task and then paying for the goods and services they didn’t produce themselves from other, similarly specialized people.

The principles of free trade are the same whether you’re discussing two neighbors or two foreigners. State borders are arbitrary and distances are, logically speaking, negligible. If free trade is harmful between producers in China and producers in the US, free trade is harmful between producers on Mayberry St. and producers on Mulberry St. one block away.

Free yourselves of the illusions of the State and suddenly economics becomes universal and sensible.

louh September 15, 2009 at 6:36 pm

I have always had a problem with comparative advantage, namely why wouldn’t a dominate producer in two industries press that advantage rather than giving way on the less dominate. It is not a finite economy, if that industry takes off you may have given up an advantage that you may not be able to reattain. I guess my question is, why can’t you do it all, or why can’t an economy have it all.

BoscoH September 15, 2009 at 6:41 pm

Because labor and capital are bounded. If one unit of labor/capital gives you $40 of bananas, and one unit of labor/capital gives you $50 of tires, you lose $10 per unit of labor/capital by making bananas. The reason you have a particular advantage in tires is because nobody can match your costs there. So focus on that higher profit activity and use the profits to buy the other things you need, which others will more gladly produce with you preoccupied with your tires.

louh September 15, 2009 at 7:00 pm

But the market for tires is finite while the overall market is not. What do you do with excess capacity at home?

Anonymous September 15, 2009 at 7:29 pm

Diversified conglomerates basically do this. GE makes refrigerators and lightbulbs and hundreds of other things. But they don’t have their best lightbulb-maker making refrigerators, even if he’s pretty good at that too.

Seth September 16, 2009 at 2:27 am

I was reading the Friedmans’ “Free to Choose” last night. The “homely example” of comparative advantage they gave was similar.

Something like, “A lawyer might type twice as fast as his secretary, but do legal work five times better than the secretary. Both are better off if the lawyer does the legal work and the secretary does the typing.”

Anonymous September 18, 2009 at 4:52 am

“Both are better off if the lawyer does the legal work and the secretary does the typing.”

What is interesting is that having the lawyer do everything, and then support the secretary, makes the sum of their incomes (“the economy”) larger still. Of course, left to his own devices, the lawyer wouldn’t do that, because he would be personally worse off than if he just fended for himself and fired the secretary. What is interesting is that you never hear socialists making that point–the point that collective wealth could theoretically maximized, according to comparative advantage, if you have the least productive people enslave the most productive people.

Instead socialists routinely criticize comparative advantage on faulty grounds. I guess it is because most socialists just aren’t intelligent enough to understand the concept.

Anonymous September 16, 2009 at 2:44 am

This one is difficult — and I have a problem with the “small business” example.

Your example works only if the captain is capable of monetizing almost every hour in their day. If not, it then depends upon their ability to monetize almost every hour in the gofers day. The captain may be worth $200 an hour — and the gofer only $25. If the gofer requires eight hours a day — or the equivalent of an hour of the captains time — then it only makes sense if the gofer is utilized over an hour a day AND the captain can monetize every hour. This is one of the reasons that almost all captains run about a half-of-a-man short. They may be worth a lot — but they can’t sell every hour — they’re not worth a lot all of the time.

In a large enterprise, all of these assumptions change.

Anonymous September 16, 2009 at 4:22 am

Comparative advantage is quite easy to layout mathematically, resulting in a linear system of equations. Doing so can be revealing. For one thing, you can show that profitable trade is possible WHENEVER two people’s productivity profiles (a profile being one person’s productivity of each task relative to an arbitrary task) are NOT identical. But of course, the larger the productivity profile, the less likely any two people will have the same one. In fact, it is almost unimaginable that any two different people will have the same profile. Comparative advantage is therefore effectively a universal law.

Anonymous September 15, 2009 at 4:23 pm

” I’m talking about the principle that you can’t talk about anything reasonable without someone countering by talking about a nationalized industry that nobody is proposing or considering.”

I understand your point, but a lot of people here would consider even a premium-funded public insurer unreasonable. The historical reality is that such user-pay systems can be in the red after time and require bailing out, can have their scope increased to resemble a nationalised system, can lead to other market restrictions (such as fast food taxes and the like), and can place unfair burden on other market participants. Not to mention that there are much simpler methods that could be tried to increase competition and reduce costs such as those mentioned by that Whole Foods guy (and by free-market economists like Professor Boudreaux.) Holding a principled stance against any government intrusion into the market is consistent with economic reality and validated by history.

Anonymous September 15, 2009 at 4:44 pm

How does being in the red bear any resemblance to national health care?

I’m no stranger to these costs and pitfalls. I say repeatedly on here that I’m leery of a public option – but think it’s worth a consideration. And if you’ll look back to the Whole Foods post you’ll note I greeted those enthusiastically too. The problem is you can’t even talk about a public option on here without someone trying to force you to defend a nationalized system. I shouldn’t have even mentioned the premiums – even if it is in the red an subsidized, that’s still completely different from a national system (ie – the system that you were discussing when you said “turns into a mandate to nationalize 1/6 of the economy”).

Holding a principled stance against any government intrusion into the market is a completely valid point to argue. What is not valid is a distortion of the opposition who never wanted nationalization anyway.

Anonymous September 15, 2009 at 5:17 pm

“How does being in the red bear any resemblance to national health care?”

I didn’t say that it did – I was addressing the word ‘reasonable’, assuming it was in reference to the public insurer plan.

Anonymous September 15, 2009 at 5:19 pm

Oh ok – well I wasn’t trying to debate the public option here. I was just raising the issue of conflating it with nationalized health care.

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