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Gains from Trade

This essay over at the Library of Economics and Liberty is part one of a two part series I’m writing on comparative advantage. I find it remarkable how poorly professors of economics (including this one) teach and understand a concept that many would label the single most important insight of the discipline.

We force our students to learn various versions of it using graphs and charts, yet its main use in the classroom is to generate tricky exam questions. Few textbooks or classes go beyond the example of two individuals or countries trading two goods. The main punchline in the typical discussion is that trade can be beneficial to both parties even when one party to the transaction is better at both things than the other. We also add that trade creates wealth. And that specialization is good.

But what is the significance beyond two people marooned on a tropical island? What does it have to do with outsourcing? What does it have to do with trade in the real world between two nations when the "nation" is not an autonomous agent making decisions but a bunch of individuals trading with another bunch of individuals across a border? How would you describe the central principle of comparative advantage using everyday English? How would that description carry over to a world with many products and many people to trade with? How do prices change the conclusions if at all, when prices are used in trade instead of barter? Does everyone have a comparative advantage in something in a multi-good multi-person world? What does that mean exactly? What if there are lots of people just like me? Do we each have a comparative advantage? Can my comparative advantage change from one good to another as the skills of others change?

In this two-part series I’ll try and get at the answers using a narrative version of the island story and avoiding the charts and graphs and equations. It turns out that even this absurdly simplified version of the absurdly simplified standard story has some real educational payoff. At least for me. I think I finally understand something about comparative advantage though I’m sure I have more to learn. It is surprisingly deep. I am grateful to my co-host here at the Cafe, Don Boudreaux, for many helpful conversations on the topic including a version of the island story that I’ve adapted as the narrative for the essay.

The second part will be posted over at the Library of Economics and Liberty on the first Monday of December.


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