Here’s the 60 second video clip explanation from the Open University.
So – I’ll be honest – comparative advantage was one of those concepts that I’ve never been truly comfortable with. Absolute advantage is easy:
- You are better at making cupcakes.
- I am better at icing them.
- Therefore, you make the cupcakes and I’ll ice them.
But what happens if you’re better both at making cupcakes and at icing them?
Is there room for me in that story?
The Good News is “yes”. Although the less good news is “you’ll benefit more than me”. But it does require us to consider a third restriction (say: “time”).
Let’s say that we have a single working day in which to make cupcakes (12 hours of time). And let’s say that it takes me 4 hours to make a tray of cupcakes, and then another 2 hours to ice them. Because there is only one of me, that means that I can make two trays of cupcakes (I’ll spend the first 8 hours baking them, then the next 4 hours icing them).
You, because you’re better than me, take 3 hours to make a tray of cupcakes, and then 1 hour to ice them. And because there is only one of you, you can make three trays of cupcakes (you’ll spend the first 9 hours baking them, then the next 3 hours icing them).
Between us, there’ll be five trays of cupcakes. And no reason to split tasks, because you’re faster at baking and icing.
Or is there?
If I don’t ice anything, and I just bake cupcakes, then I’ll produce three trays of cupcakes. You can produce two trays, ice them, and then ice my three trays, and we’ll still have five trays of cupcakes.
Only, you’ll have done the work in 11 hours (6 hours of baking and 5 hours of icing). And you can spend the last hour doing something else…
Over time, that extra hour of time each day can be used to produce more cupcakes collectively. So we’ll all win (although you’ll probably win more than me).