Overview

This is the most counter-intuitive idea in economics. It explains why trade is good, even if one person is better at everything. Even if LeBron James is better at mowing lawns than his gardener, he should still hire the gardener. Why? Because every hour LeBron spends mowing is an hour he isn’t playing basketball.

Core Idea

The core idea is Opportunity Cost. It’s not about who is faster (Absolute Advantage). It’s about what you give up to do it.

Formal Definition

The ability of an individual or group to carry out a particular economic activity (such as making a specific product) more efficiently than another activity. Discovered by David Ricardo in 1817.

Intuition

  • Scenario:
    • USA: Can make 10 Planes or 100 Shirts per hour.
    • Vietnam: Can make 1 Plane or 50 Shirts per hour.
  • Analysis: The USA is better at both.
  • The Trade:
    • For the USA to make 1 Plane, it gives up 10 Shirts.
    • For Vietnam to make 1 Plane, it gives up 50 Shirts.
    • The USA has a “Comparative Advantage” in Planes (lower cost).
    • Vietnam has a “Comparative Advantage” in Shirts.
  • Result: USA should make only Planes. Vietnam should make only Shirts. They trade. Both get richer.

Examples

  • Lawyer vs. Typist: A lawyer might be a faster typist than her secretary. But she charges $500/hour for law and the secretary costs $20/hour. She should do law and let the secretary type.
  • Global Trade: Why do we buy bananas from Ecuador? Not because we can’t grow them in greenhouses in New York, but because it would be incredibly expensive (high opportunity cost).

Common Misconceptions

  • Trade kills jobs: It kills inefficient jobs (making shirts in the USA) but creates efficient jobs (making planes). The problem is that the shirt-maker doesn’t automatically become a plane-engineer. (Frictional Unemployment).
  • Protectionism: Tariffs to stop trade. Economists almost universally hate this because it ignores Comparative Advantage and makes everyone poorer.
  • Specialization: Doing one thing well. The basis of civilization.

Applications

  • Career Advice: Don’t try to be good at everything. Find your comparative advantage (what you are good at relative to others) and double down on it.

Criticism / Limitations

  • National Security: Maybe we should make our own computer chips even if it’s expensive, just in case of war. Efficiency isn’t everything.

Further Reading

  • Ricardo, David. On the Principles of Political Economy and Taxation.