Monday, April 11, 2011

CHAPTER 9: Economics in a nutshell.  People discovered the economic benefits of specialization and trade.  To facilitate trade they discovered money.  To minimize conflicts they discovered property.  The rest is history.

Every choice involves an OPPORTUNITY COST.  When you choose A instead of B you give up any benefit you may have obtained from B.  Simple enough.  Economists call this problem "scarcity".  In other words you can't have your cake and eat it too. 

When you choose to produce X instead of Y then the value of Y to you is the opportunity cost of producing X.

Every person is an individual therefore opportunity costs vary individually.

Let's say in one hour Smith can produce either 1X or 2Y's. 

Jones can produce either 2Xs or 8Ys.  Stay with me here.

Jones has an ABSOLUTE ADVANTAGE in producing both Xs (2>1) and Ys (8>2).

However Smith has a COMPARATIVE ADVANTAGE in producing Xs because his opportunity cost is lower (2<4).

Jones has a comparative advantage in producing Ys for the same reason (1/4<1/2).  Concentrate now.  This really isn't that hard. 

After specializing according to their comparative advantages Smith and Jones agree to trade 1X for 3Ys.

This is good for Smith because with 2 hours of work he can now have 1X and 3Ys instead of 1X and 2Ys.

This is also good for Jones because in 2 hours of work she can now have 10Ys and 2 Xs instead of 8Ys and 2Xs.

The implications of this simple example are enormous.  Both parties benefit.  It is a win-win game. 

That is why when you trade with someone it is appropriate for both to say thank you.  Mutual benefit.

Comparative advantage is the basis for specialization.  Specialization is the basis for trade.  And trade is the basis for mutually beneficial human relationships. 

In a simple primitive barter economy with only a few products this would be the end of the story. 

But what if there are millions of people and millions of products.  This could get complicated. 

How complicated could it be you ask.  Read this essay and you'll see.

Then read this one.

Review Questions:  If  Mr X has an absolute advantage in producing both A and B can Ms Y have a comparative advantage in producing  either A or B?  Explain. Why dont' we need a Pencil Czar to coordinate the production of pencils?  If we did have a pencil Czar would we have any pencils?

No comments: