Scott Sumner  

No, the public doesn't understand comparative advantage (or supply and demand)

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Noah Smith recently made this claim:

Maybe people are perfectly smart and rational enough to understand the David Ricardo idea, and also smart enough to understand something else that economists have known for 200 years -- international trade doesn't necessarily benefit everyone within a country.
I doubt it. Years ago Paul Krugman brilliantly demonstrated that even most experts don't understand "Ricardo's Difficult Idea." More recently Nick Rowe had a post responding to Smith, where he basically took the Krugman position. He ended with this depressing anecdote:
One other related anecdote from that era: for some forgotten reason I was a reviewer for the proposed Ontario high school economics curriculum. One item on the proposed curriculum was the gains from trade due to differences in absolute advantage. I said it should be comparative advantage. They said it was too hard to teach comparative advantage. I said they should teach comparative advantage even if it meant deleting everything else from the curriculum, or else not teach gains from trade at all. They thought they had an eccentric cranky professor on their hands, and would only accept my recommendation if it were supported by other chairs. Which is why, somewhere deep in the silicon records, there are emails from the chair of every single Ontario economics department saying we should teach that the gains from trade come from comparative advantage not absolute advantage. I fear that some may still be teaching the case where England has an absolute advantage in wheat and Portugal an absolute advantage in wine. And stopping there. And that's the kids who actually take economics at high school.
This reminded me of my daughter's international business textbook. (She's in 10th grade, at a highly rated public school.) The book (by Dlabay and Scott) is just a complete disaster. Here's the definition of absolute advantage:
Absolute advantage exists when a country can produce a good or service at a lower cost than other countries.
Ouch. (That's comparative advantage.) A few pages later is this gem:
The final indicator of a country's economic situation is the unemployment rate. When people are not earning an income, they cannot purchase needed goods and services. This causes other people to lose their jobs.
Got that? Unemployment is caused by unemployment. A few pages earlier they distinguish between LDCs and industrial countries. Then they mention:
Between the extremes of economic development are the developing countries that are evolving from less developed to industrialized.
The book says the LDCs include Ethiopia and Hungary, and the "developing countries" include India and Singapore. Whatever.
The United States, Germany, and Japan are considered developed countries. However they still suffer from many of the issues that plague underdeveloped countries, such as hunger and homelessness.
I suppose that's technically true, but of course it's going to give students a hopelessly misleading impression of the relative scale of poverty in the LDCs.

Not sure any of this matters. The better students will pick up what they need, when they need it. Any student that plans to become an economist will eventually learn comparative advantage; just as a student that plans become a biologist will eventually learn evolution, even if they are home-schooled by a fundamentalist in the Bible Belt. The best argument for voucher schools is not that they can produce smarter students, but rather that they can produce equally uneducated students at a cost savings of hundreds of billions of dollars. Money that could be used to subsidize the wages of low-skilled workers.

PS. Supply and demand? Sometimes I wonder if that should be left for grad school. Not one student in a hundred can avoid reasoning from a price change.


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COMMENTS (33 to date)
E. Harding writes:

So, what's the actual definition of "absolute advantage"?

foosion writes:

When will Intro to Economics by Scott Sumner be published?

"Absolute advantage exists when a country can produce a good or service at a lower cost than other countries."

Ouch. (That's comparative advantage.)

------------------

Are you sure? I think that they are correct.

"The ability of a country, individual, company or region to produce a good or service at a lower cost per unit than the cost at which any other entity produces that good or service."

http://www.investopedia.com/terms/a/absoluteadvantage.asp#ixzz3Z1X4j9EW

"In economics, the principle of absolute advantage refers to the ability of a party (an individual, or firm, or country) to produce more number of a good product or service than competitors, using the same amount of resources."

http://en.wikipedia.org/wiki/Absolute_advantage

Other sources say pretty much the same thing.

vikingvista writes:
"Absolute advantage exists when a country can produce a good or service at a lower cost than other countries."

Ouch. (That's comparative advantage.)


I suppose one could define "cost" in two different ways, one which defines absolute advantage and the other comparative advantage. But assuming opportunity cost, this is comparative advantage (usually easier understood considering two parties and two kinds of products).

joemac writes:

Scott,

I guess this is a silly question, but how do you know the theory of supply and demand is true? Could it be false?

Ricardo Cruz writes:

joemac, we can never know anything for certain. We do not know if next time we drop a rock, it will fly. We use evidence wrapped up in theory to make as much sense as possible of the world (=science).

Michael B. writes:

Absolute advantage is when a country can produce EVERY good at a lower cost than other countries...not just one good that is of lower cost.

Scott Sumner writes:

E. Harding, Ability to produce more of something, perhaps per unit of input (such as acre of land.)

Foosion, I'm probably too controversial.

Mark, That site is hilarious. They get almost everything backwards. Most of that page is describing comparative advantage. Maybe that's what the textbook writers relied upon.

joemac, All economics theories are at least slightly false. The real question is whether it's useful. It's useful for many industries, especially commodity-type industries.

Chris writes:

Scott,

I think you missed on this one. Assuming the textbook is defining cost the way most high school students understand it (i.e. not opportunity cost), a country does have an absolute advantage if it can produce a good for lower cost. It is of course true that a country that can produce at a lower cost can also have a comparative advantage, but so can a country that produces every good at a higher cost, but one relatively more efficiently.

Michael B,

I don't think that's quite right. Even Nick's post talks about having an absolute advantage in one commodity.

Jon Murphy writes:

Absolute advantage is when a country (firm/individual) can produce more at a lower absolute cost. Comparative is when a country (firm/individual) can produce at a lower opportunity cost.

Example:

a farmer can produce an oz of meat in an hour and an oz of potatoes in 15 minutes

A rancher takes 20 minutes for meat and 10 min for potatoes.

The rancher has absolute advantage in both (he can produce both potatoes and meat at a lower cost [time] then the farmer).

But the farmer has comparative advantage in potatoes because his opportunity cost of potatoes is lower than the rancher's (and vise versa, the rancher's opportunity cost of meat is lower than the farmer's).

Don Geddis writes:

Chris: "Assuming the textbook is defining cost the way most high school students understand it"

And how is it, exactly, that you think high school students understand "cost"? Presumably, the dollar amount of the price tag in the store. But that doesn't apply to multiple nations with independent currencies. If the US can produce a gallon of milk for $3, and Mexico can produce it for 10 pesos, which country can produce milk for "lower cost"? What is the sensible way that you imagine high school students understand that question?

Chris writes:

Don,

Of course if there are different currencies involved it makes the answer harder to see, but we could simplify by just thinking in terms of 2 US firms producing 2 goods. Jon's example hits the point exactly. I would bet that most high school students think in terms of absolute cost. If one firm is more efficient (either in time as in Jon's example or in dollars) at producing both goods, it seems like it should produce both. But comparative advantage is about relative costs. By producing one of the goods, the firm loses the opportunity to use those resources to produce the other good (it has a higher opportunity cost). Even though it would take fewer resources (high school definition of cost) for the efficient firm to produce the goods, the lost opportunity represents a larger loss (economist's definition of cost).

Cloud writes:

The worst problem is in university student recruitment....

Take me as an example, I always got As in all the economics public exam in high school, but Ds in all other subject.

I think I am more worthy than most to go in Chicago Undergraduate program ~~

(half joking)

I want to say is that, there are no Economics Departments all over the world even considered using Ricardo 's idea to pick students.... Why?

Comparative advantage is why we (rich countries) should accept more low skilled immigration. Absolute advantage is why we should not. Since most people, including the elites, believe (or at least alieve) in the absolute advantage model, low-skilled immigrants are not welcomed.

People are literally dying in the Mediterranean because the public does not get comparative advantage, at the rate of 10 deaths a day.

Matthias writes:

Comparative advantage occurs in our office every day. I am better in economic analysis, and due to my skills in using shortcuts I'm also much faster at updating addresses in our database then our secretaries. So I have absolute advantage over our secretaries.

But my company profits much more from me when I do only economic analysis and don't spend any time on the database. Thus our secretaries have comparative advantage in updating the address database.

In other words: Everybody uses the concept of comparative advantage all the time, they just don't know it.

mbka writes:

Scott, somewhat related, I'd like your opinion on the MIT-Harvard Atlas of Economic Complexity (Hausmann et al. 2008, 2013), link . The primary finding, unsurprising but well presented, is that higher productivity economies are more complex than lower productivity ones. The authors in their introduction, state that this empirical fact runs counter Ricardo. They claim that per Ricardo, one would have expected higher productivity from increased specialization between countries. But empirically, higher productivity is tied with higher economic complexity within a country and therefore not with any kind of between-country specialization.

I don't follow that conclusion because (1) increased within-country economic complexity implies increased specialization, only within-country, although admittedly that's parallel reasoning more in the domain of Smith than Ricardo, and (2) the statement "complex economies are usually richer than simple ones" addresses absolute advantage, not comparative advantage. What is your opinion on this?

Don Boudreaux writes:

I'd like to make a point that I believe no commenter has yet made.

When Noah Smith says "international trade doesn't necessarily benefit everyone within a country" he is correct, but only in a far more restricted and less policy-relevant way than I suspect he thinks.

Such a statement is true only insofar as it is a particular way of saying that competition doesn't necessarily benefit everyone within a country. Of course competition, at any moment in time, has "losers" (if you'd like to call them that): firms and workers that lose market share and jobs, often significantly so, to other firms and workers. Those are unavoidable - even essential and (as Schumpter especially made clear) beneficial- features of competitive market processes.

The point is that there is nothing at all unique about the competition that occurs across political borders that creates such "losers." So to indulge in the familiar caveat that Noah Smith here (like many, many others) indulges in - to say 'of course free trade has losers in addition to winners' - is to suggest that there's something unique on this front about trade that occurs across political boundaries. That international (or free) trade has "losers" no more suggests that government policy should aim to stem the source of these losses any more than does the fact that competition in general has "losers" suggest that government policy should aim to diminish competition generally in order to diminish such losses.

Of course, one can favor government policies to protect those who "lose" from competition. But there's no reason to limit those policies to the protection of only those firm and workers who happen to lose to international, rather than to purely domestic, competition.

By the way, I put "losers" in quotation marks because, when the time span under consideration is expanded, those who "lose" today from market-induced changes in the pattern of economic activity (i.e., competition) are seen over time in fact to have reaped large benefits from being part of a competitive economy. The workers who "lose" today because, say, some fellow citizens choose to purchase more foreign-made goods themselves almost certainly earlier gained by their, and their employers, having been able to trade freely in international markets. More importantly, over time, many of these workers - and certainly their children and grandchildren - will be genuine losers if and to the extent that their government keeps "loss-diminishing" trade restrictions in place.

Yaakov writes:

As a non-economist reader of economic blogs I would like to propose the following rule:

"when noting a mistake in basic economics, the writer should give a clear explanation of the mistake to be understood by the layman."

Don Boudreaux writes:

On the question "What is absolute advantage?" I've long been of the same mind as Royall Brandis, who wrote - in the March 1967 issue of the American Economic Review - a wonderful short article entitled "The Myth of Absolute Advantage."

Adam Simpson writes:

"In other words: Everybody uses the concept of comparative advantage all the time, they just don't know it."

I really enjoyed your example as that's how, despite my degree in Economics, I best understood the principle, years later, by folks such as Don Boudreaux.

I'd add to the last part that not only do they not realize the concept they use at work is the same one used to describe the benefits of free trade, but when it becomes "us v.s. them" (although it shouldn't, as it does whenever international trade is discussed) most forms of valid reasoning fly out the window.

David R. Henderson writes:

@Don Boudreaux,
I just pulled down that article and read it. It makes sense. So when you teach comparative advantage, I would guess that you don’t even mention absolute advantage, right?

Scott Sumner writes:

Chris, That's just flat out wrong. Lower cost means comparative advantage, even if defined in money terms (which is how I presume high school students think of cost.)

Absolute advantage is about productivity, it has nothing to do with cost.

Jon, You are describing productivity, not cost.

mbka, I'm afraid I don't follow their logic. There are many factors influencing complexity; Ricardian considerations are just one.

Don, Very good point.

Yaakov, Sorry, the definition they provided is actually for comparative advantage. The country that can produce at a lower cost has a comparative advantage. It's just that simple.

Absolute advantage is when you can produce more of something, perhaps per unit of input.

Don Boudreaux writes:

David,

I mention absolute advantage only to note that it's a myth - that it's, at best, a name for an illusion. (I want my students to be familiar with the term, because it's commonly used.)

Yancey Ward writes:
Not sure any of this matters. The better students will pick up what they need, when they need it.

Wish the first sentence was true, but then the ones who don't pick it up are most of your voters, and probably a majority of your political leaders.

Jon Murphy writes:

Jon, You are describing productivity, not cost.


Ah, you are right! I had to re-read what I wrote a few times to understand what your said, but I see you are absolutely right!

Chris writes:

Scott

I still think it's just a matter of the definition of cost. You say absolute advantage is being able to "produce more of something, perhaps per unit of input." Let's say the input costs 5 dollars (and depreciates immediately after use). One firm can produce 2 units of the good per unit of input. The other can only produce 1. Then it costs firm 1 $25 to produce 10 units of the good and it costs firm 2 $50 to produce the same amount. In that sense, firm 1 can produce 10 units at a lower cost than firm 2 and has an absolute advantage in the production of this good. We both know this is not the way economists should think of cost (you're right that it is just productivity that matters), but I am 99% sure that this is the point the textbook writers were trying to make and an explanation that would appeal to high school students who have not fully grasped the concept of opportunity cost.

We can also look at the classic example of two people on an island who can produce either coconuts or fish, where each take time to produce. For an economist, the cost of producing one fish is the amount of coconuts you could have instead produced with that time. I can't be sure, but I think if you asked most non-economists what the cost of producing fish is they wouldn't think about coconuts at all, but rather define cost in terms of the time it took to produce the fish (If they don't just say it was free, since they didn't have to pay anything for it).

So I guess my point is that the confusion is not over absolute advantage vs comparative advantage, but cost vs productivity.

Chris writes:

Don,

I would be curious to hear your thoughts on the two comments that were given to Brandis' original article.

Ingram and Anspach

Brandis gave a reply here, but it doesn't seem to fully address their points. Ingram's view in particular matches my own pretty closely. Brandis seems to get hung up on the fact that the model doesn't explain why productivity differs in the two countries, but that seems to be a different point than the one Ricardo and Ingram make. They assume productivity is different (the reason is irrelevant) and then show that if factors are immobile a country can have an absolute advantage. As Ingram states in his conclusion, whether or not it is a useful concept is another issue.

vikingvista writes:

If I am more productive than you at everything I do, does that not mean I have an *absolute advantage* in those things over you, while you (assuming you have different productivity ratios than I) have a *comparative advantage* in some things?

Unfortunately JSTOR won't let me buy the article Prof. Boudreaux linked, so I'm at a bit of a disadvantage.

Chris writes:

"As a first step in developing this principle, consider the following question: In our example, who can produce potatoes at lower cost—the farmer or the rancher? There are two possible answers, and in these two answers lie both the solution to our puzzle and the key to understanding the gains from trade.

One way to answer the question about the cost of producing potatoes is to com- pare the inputs required by the two producers. The rancher needs only 8 hours to produce a pound of potatoes, whereas the farmer needs 10 hours. Based on this in- formation, one might conclude that the rancher has the lower cost of producing potatoes."

Mankiw, Principles of Economics page 53

Two definitions of cost, one (what I've been calling the non-economist version) related to absolute advantage and the other (opportunity cost) related to comparative advantage. As I said, I'm pretty sure the high school textbook meant the former in its definition as it is much more natural for a first time economics learner. Also pretty sure Mankiw understands the concept of comparative advantage.

HettGutt writes:
Chris, That's just flat out wrong. Lower cost means comparative advantage, even if defined in money terms (which is how I presume high school students think of cost.)

Scott, save some face here; you don't know the difference between comparative and absolute advantage. If you're interested, I'll be teaching Intro Micro this Fall. Sounds like you need it. If it takes Norway fewer inputs - lower cost - to produce 1 unit of X than Italy, Norway has an absolute advantage in X. It's all there, black and white, clear as crystal! You get nothing! You lose! Good day, sir!


Quinn writes:

I don't think I have ever learned comparative advantage and absolute advantage in terms of commonly understood cost (not opportunity cost). It was all about production and what you sacrifice of 'Y' to produce more of 'X'.

A writes:

Hettgutt,

I think you are making the same assertion as commenter Chris. You are making a statement that potentially mingles absolute and comparative advantages, without usefully distinguishing the concepts.

Norway may be more efficient with a given input, an absolute advantage, while also facing greater opportunity costs for that input, a comparative disadvantage. Or, it could be a comparative advantage. The statement does not clarify. If you are teaching your students in this manner, then you are being ambiguous with respect to efficiency or opportunity costs. Why embed such confusion in the introductory courses?

Jose Romeu Robazzi writes:

Worried about comparative advantage? In Brazil the leftist ruling party manage to produce early school text books that lay out mankind's evolution:
hunter gatherers -> agriculture based empires -> feudalism -> mercantilism -> capitalism -> socialism -> comunism .... depressing ...

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