No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Two: Fundamentals of Economic Behavior 52 Trade, or voluntary exchange, benefits both parties to the exchange. Otherwise they wouldn’t voluntarily engage in trade. The extent that each one benefits depends upon their individual skill as a negotiator—clearly one party to exchange can benefit proportionately more than the other if he or she strikes a better bargain. Yet, both must benefit to some degree, based on our earlier assumption that people prefer more to less. Of course they might not actually benefit in hindsight; their expectations of how the item might satisfy their needs may disappoint. How many of you have purchased something at the store and later regretted it? But at the time of purchase you thought it was definitely worth the money. There is a common misconception that trade is not beneficial in all cases, especially in public policy discussions of trade with other countries. Here we shall see that what is true for an individual is also true for the nation. The thinking goes like this: if an individual or nation can do everything better than another individual or nation, then it doesn’t make sense to trade. If our goal is to maximize total production of goods and services, we will see this conclusion is in error. An individual may have an absolute advantage in every possible exchange, and yet it still makes sense to trade. The reason is because everyone has a comparative advantage that makes him or her a relatively better producer of that item. Let’s start with some examples to see how this works and what we mean by the terms “absolute” and “comparative” advantage. Say Mary is a fantastic lawyer, and earns $500 per hour in her legal practice. But Mary is also an excellent typist; she can type over 100 words per minute without error! Her secretary Martha is only average, typing 40 words per minute, and earns $10 per hour and can’t provide legal services at all. Given that Mary has an absolute advantage over Martha in both typing and legal services (she can do more of both tasks), maybe she should just fire Martha ( Table 2.1 ) ? A little math should answer that question. Let’s say that Mary’s legal practice has a lot of typing requirements, and she conveniently has 19,200 words to type per day. If Martha takes no breaks, it will take her 8 hours to type the total 19,200 words each day. Since she is paid $10/hr., it only costs Mary $80/day to accomplish the necessary typing by hiring Martha. Now let’s see the cost of doing it herself. With 19,200 words to type, at 100 words per minute, Mary will have 192 minutes of typing. This will cost her 3.2 hours of her time. Now the opportunity cost comes in. What would she have done with 3.2 hours? Of absolute advantage: an individual (or firm, or country) is said to have an absolute advantage if he can produce any given good or service with fewer resource inputs than his potential trading partner comparative advantage: an individual (or firm, or country) is said to have a comparative advantage if she can produce any good or service at a lower opportunity cost than her potential trading partner Mary Martha Typing 100 WPM 40 WPM Legal Services $500/hr. $0/hr Table 2.1. Sarah has an absolute advantage in both!