Economics 101

The eighteenth century, also known as the Age of Reason, or the Enlightenment, saw a fundamental shift in the way people viewed their world. The year 1776 was especially important, for it not only was the year that Thomas Jefferson wrote the Declaration of Independence, but it was also the year that Adam Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations was published.

An embargo is a ban on trade with another country.

Quotas are limits on trade

A tariff is a tax on trade

Tariffs are not without their downsides:

Protective tariffs often have the effect of preventing competition and encouraging waste and inefficiency.
Revenue tariffs often fail to raise tax revenue because people stop buying the now-expensive imports.
Export tariffs might give producers an incentive not to produce.

Despite its obvious benefits, free international trade has many detractors:

Environmentalists are concerned that as countries specialize, production will concentrate in countries that have fewer regulations to protect the environment from pollution and habitat destruction.
Labor unions oppose free trade on the grounds that production will shift toward low-wage countries that have little or no union representation, and therefore negatively impact their membership.
Human rights activists often oppose free trade as production shifts toward countries where working conditions are miserable and often inhumane, and where workers are not afforded the same rights and privileges as in industrialized nations.
Politicians and their constituents concerned with loss of national sovereignty often oppose free trade agreements on the grounds that decisions affecting the nation are being made by an international body not directly subject to the people.

So what does this have to do with comparative advantage? An example might help. Consider 100 typical American high school students and then consider 100 young people of the same age in Bangladesh. In which country is the opportunity cost of producing a T-shirt higher? If you look at the American students, you would have to agree that they have more opportunities than the Bangladeshi. When Americans specialize in T-shirts, more potential doctors, nurses, teachers, engineers, mechanics, firefighters, police officers, business managers, machinists, and social workers are sacrificed than in Bangladesh, where the majority of workers will most likely become subsistence farmers. The opportunity cost of producing T-shirts is much lower in Bangladesh than in America, and therefore Bangladesh has a comparative advantage in producing T-shirts. Even though the United States has the capacity to produce T-shirts more efficiently (absolute advantage), from an economic standpoint, it makes sense to trade pharmaceuticals, refined chemicals, capital equipment, and know-how for T-shirts.

In the past, dropping out of high school and working at the mill or the factory was the norm; today, dropping out of high school is cause for concern. There are more jobs as well as more job titles than there were sixty years ago. In other words, there are greater opportunities today than there were sixty years ago. Of course, this comes with one major catch: You must have the education or training in order to take advantage of the opportunity.

Remember to always count the opportunity cost.

A comparative advantage exists if you can produce a good at a lower opportunity cost than someone else. In other words, if you sacrifice less of one good or service to produce another good or service, then you have a comparative advantage. In the example given earlier, Art and Paul are songwriters, but what if both are also capable of performing complex brain surgery? If Art and Paul can both successfully complete two brain surgeries in an hour, then which has a comparative advantage in songwriting, and which has a comparative advantage in brain surgery?

To calculate the comparative advantage, you must determine the opportunity cost that each person faces when producing. In Art’s case, for every hit song he writes, he sacrifices two successful brain surgeries. In an hour, Paul can produce either two hit songs or two brain surgeries. This means that Paul sacrifices one brain surgery for every hit song he writes, and therefore, has the comparative advantage in songwriting. Art, on the other hand, has the comparative advantage in brain surgery because for every brain surgery he performs, he only sacrifices half of a hit song, compared to Paul, who sacrifices a whole hit song for the same surgery. In conclusion, Art should specialize in brain surgery and Paul in songwriting because that is where they find their comparative advantage.