Description:

We continue our discussion about the benefits of exchange by taking a deeper look at the concepts of division of labor, specialization, and comparative advantage. Everyone stands to gain from trade. Increased division of labor, specialization, and gains from trade are the keys for unlocking prosperity.

In this lesson, students will watch two videos about the importance of specialization and trade with Professor Art Carden. Next, students will read an article about comparative advantage. Lastly, students are treated to a two-part story called Treasure Island that can be read in class or as a Self-Study assignment.

 

Time Required:

45 min

 

Required Materials:

Internet connection, writing instrument 

 

Prerequisites:

Module 2 – What is the Entrepreneur’s Role in Creating Value?

Module 3 – How Can Entrepreneurs Use Economics to Make Better Decisions?

4.3.A – Watch and discuss the following video using the questions below to guide your discussion [15 min]:

Video:(Learn Liberty, 2:43 min)

“Free Trade and Comparative Advantage - Professor Art Carden is able to mow his yard, build a fence, and install a faucet all at the same time. How? He does this by specializing through trade. Rather than try to do those things himself—especially since he isn’t very good at doing them—he uses the money he earns doing what he specializes in to pay others to mow his yard, build a fence, and install a faucet for him.”

Discussion Questions: Specialization and Trade: Because We Can’t Be Good At Everything

1.  Why should people specialize and trade for the goods and services they need, even if they are absolutely better at everything?

  1. Professor Art Carden explains specialization: “What’s cool is this works even when one person is absolutely better at everything than his or her trading partner.”
  2. Using the example of himself and Wes in the  Wes can both write economics lectures and mow lawns faster than Professor Carden can do either. Wes can write a lecture in an hour or mow a lawn in 30 minutes. However it takes Professor Carden two hours to mow a lawn or an hour and a half to write a lecture. If they both specialize with Wes mowing a lawn and Professor Carden writing lectures and then trade, they each save themselves half an hour. Gains from trade!
  3. People and countries should specialize in what they are comparatively good at doing (what they can produce at a lower opportunity cost).
  4. By specializing in things where we have a comparative advantage, both parties involved in the exchange can save time and can consume more goods and services than they could without trade. Learn more about Comparative Advantage.

 

2.  How does trade create wealth?

  1. In the video, Prof Carden explains that he is not good at cutting grass, building fences or installing faucets. However, in a way, he can accomplish all of these at the same time if he specializes in what he is good at (teaching economics) and trades with others.
  2. If Prof. Art Carden focuses on teaching economics, he is able to pay someone to perform these other services for him. In doing so he saves himself time. Prof. Carden is now wealthier with trade because he is able to consume a wider variety of goods and services in less time than it would have taken for him to produce these things independently.

 

4.3.B – Watch and discuss the following video using the questions below to guide your discussion [15 min]:

Video:(Learn Liberty, 2:46 min)

“How does trading make people better off? Economics professor Art Carden explains in this quick lesson on one of the most important concepts in Economics 101.”               

Discussion Questions: Trade Is Made of Win

1.  Would you trade with someone if you thought the item you are trading for is worth less to you than the item you currently have? What if you thought the items had the exact equal value?

  1. People do not trade unless they expect to benefit from the trade. In a voluntary exchange, each party values what they receive more than what they give up. There would be no reason to trade if an individual valued two goods to be exactly equal in value.
  2. Some people think that in order for one person to “win” in a trade it means another person must “lose.”  Trade is a positive sum game, meaning that both parties win in a trade. Hence the title of this  “Trade is Made of Win.”

 

2.  How does trade create wealth, even if no additional goods are produced?

  1. Remember, more wealth doesn't necessarily mean "more stuff." It often means getting stuff into the hands of the people who value it most. Because people value items differently, there can be mutual gains from trade. 
  2. All trade participants benefit when people specialize in producing the goods they have a comparative advantage in producing (goods they can produce at the lowest opportunity cost) and then trading with other people for the things they want and need.

Teacher Tip: This article contains slightly more advanced material.


4.3.C - Read the following article using the questions below to guide your discussion [15 min]:

Article: Comparative Advantage  by Lauren F. Landsburg (econlib.org)

“A person has a comparative advantage at producing something if he can produce it at lower cost than anyone else. Having a comparative advantage is not the same as being the best at something. In fact, someone can be completely unskilled at doing something, yet still have a comparative advantage at doing it! How can that happen?”

Discussion Questions: Comparative Advantage 

1.  What is the difference between having an absolute advantage versus having a comparative advantage?

  1. A person with an absolute advantage means he or she is best at doing that activity. For example, LeBron James has an absolute advantage playing basketball against just about anyone.
  2. Having a comparative advantage means being able to produce a good or service at a lower cost than anyone else.

 

2.  Why is the concept of comparative advantage, which David Ricardo illustrates, so crucial to understanding why trade is beneficial to both parties?

  1. “Comparative advantage explains why a country might produce and export something its citizens don't seem very skilled at producing when compared directly to the citizens of another country!”
  2. “The explanation of the apparent paradox is that the citizens of the importing country must be even better at producing something else, making it worth it for them to pay to have work done by the exporting country.”

 

3.  Use the concept of comparative advantage to explain how even the most disadvantaged gain from trade.  

  1. The magic of comparative advantage is that everyone has a comparative advantage at producing something.
  2. To find people's comparative advantages, do not compare their absolute advantages. Compare their opportunity costs.
  3. The upshot is quite extraordinary: Everyone stands to gain from trade. Even those who are disadvantaged at every task still have something valuable to offer.

 

Teacher Tip: Teachers should assign Self-Study reading 4.3.D at the end of class.


4.3.D – Self-Study: Read the following two articles which illustrate the idea of specialization and comparative advantage in the form of a story. Then answer the questions that follow. [30 min]

Article: Treasure Island: The Power of Trade. Part I. The Seemingly Simple Story of Comparative Advantage (econlib.org)

Article: Treasure Island: The Power of Trade. Part II. How Trade Transforms Our Standard of Living (econlib.org)

Discussion Questions: Treasure Island

1.  “Self-sufficiency is the road to poverty. Trade creates wealth by letting me use your skills along with mine.” Explain, using the example on Treasure Island how specialization and trade make people better off, even when some people are absolutely better at producing all goods or services available?

  1. The author explains “I told the story of the Fishers and the Palmers, two newly-wed families shipwrecked on a tropical island, desperately seeking food and water. The palmers can barely gather enough fish and fresh water to survive. The Fishers are better at both. But even though the Palmers are inferior in both tasks to the Fishers, they still have something to offer in trade – their time. By collecting water for the Fishers, the Fishers have more time to fish. And by fishing for the Palmers, the Fishers create more time for the Palmers to collect water.”
  2. Through specialization and trade both parties always benefit and increase their own wealth even if one party is absolutely better at producing everything. This is because when people specialize and trade they save themselves time and are able to consume more – both families in the story end up better off because they all get more fish.

 

2.  The author states that none of the scenarios at the end of the essay should be stopped from occurring. Why? How do these scenarios represent real life issues?

  1. None of the scenarios at the end of the essay should be stopped from occurring. They are all simple examples of the consequences of trade and innovation. When new trading partners, who are more efficient at producing something, or more innovative, enter the market everyone benefits.
  2. For example, if the first scenario occurred the Fishers may become despondent, but will be relatively better off. They too could fetch water and trade it for more fish or could do something else entirely. Everyone is better off – the fisherman has fresh water and both families have more fish to eat.
  3. These examples represent trading and innovation in the market. If there are protectionist policies that do not allow trading between countries, or barriers to innovation everyone becomes worse off. In the short run people may lose jobs when new trading partners enter the market, but their time and resources can be re-allocated to more efficient uses. Everyone becomes better off because they save time and can consume more and a wider variety of goods and services.

 

3.  What does it mean for someone to have a ‘comparative advantage’ at producing something? Do all people have a comparative advantage?

  1. The author explains “The lesson is that the best use of your time in a world of trade depends on the skills of others. Our differences create the potential for specialization and the creation of wealth.” And “The lesson of comparative advantage is that while anything we do is worth doing well, not everything we do well is worth doing.
  2. A CEO who is a great cook still orders take out, even take out that isn’t as good as what the CEO can make. The cost of cooking isn’t just the grocery bill – it’s the time taken away from managing the company.

Lesson Recap

 
  • Everyone has a comparative advantage at producing something.

 

  • To find people's comparative advantages, do not compare their absolute advantages. Compare their opportunity costs.

 

  • Everyone stands to gain from trade. Especially those who may lack the absolute advantage at producing a good or service.

 

  • Trade is a positive sum game, meaning that both parties win in a trade.

 

  • There can be mutual gains from trade because people value items differently.

 

 

Additional Resources

Article: Specialization and Exchange by Gene Smily (FEE.org)

“The advantages of this market process are so obvious most of us simply take them for granted”. Dr. Smily, an Associate Professor of economics at Marquette University, explains the benefits from specialization and trade as well as the effects on the market when policies interfere with free trade.”

 

Article: A Marvel of Coordination: How Order Emerges Without a Conscious Planner by Russell Roberts (Library of Economics and Liberty)

“How is it that millions of people every day cooperate with millions of others to get the bagel to your corner coffee shop? There’s no government agency or central hub where all the commerce originates. The web of connections holding the system together are unseen”

 

Article: A Brief History of the Concept of Comparative Advantage by Morgan Rose (Library of Economics and Liberty)

“For over 200 years, economists have touted an alternative approach in which specialization leads to wealth and self-sufficiency leads to poverty. In Book 4, Chapter 3, Paragraph 31 of An Inquiry Into the Nature and Causes of the Wealth of Nations, Adam Smith showed how both parties can benefit from trade, but it was David Ricardo who is credited with what is commonly called “comparative advantage”, the idea that both parties can benefit from trade even if one of them is better at producing everything than the other.”

Last modified: Monday, August 13, 2018, 12:53 PM