Exercise 2.1:
So who does the typing when the boss is faster than the secretary?

A famous and wealthy impresario of stage and screen in the 1940s, Billy Rose was also a world-class typist and stenographer with many awards to his credit. He would thus have encountered enormous difficulty in hiring a secretary who could work nearly as well as he himself could. Still he hired secretaries…1

Have you ever wondered why Paul Prudhomme (a famous New Orleans chef) can be seen in someone else's restaurant eating food that is simply not a good as the food he can cook himself? The reason is called comparative advantage. Just like Billy Rose, Chef Paul is one of the best in his field, yet he hires others to do for him what he can do better for himself. This arrangement is not unusual. In fact it is not at all uncommon. Billy Rose was a better manager of an entertainment empire than his secretary and, simultaneously, a better typist. Let's assume for a moment that he was twice as fast a typist as his secretary-what took him two hours to accomplish he could have done in one hour. However, he could make a great deal more money in one hour as a manager than he paid his secretary for two hours of typing. Thus it was in his best interest to hire a secretary and have him do the typing while Mr. Rose managed the business.

In the case of Chef Paul it takes him the same amount of time to eat whether or not he cooks the food himself. However, he can spend time cooking a meal he can sell at K-Paul's Louisiana Kitchen for $80 rather than spend the time preparing a meal for himself. If he can go to another restaurant for lunch and spend less than $80, he is better off to eat there, even though the chef may not be of quite the same caliber.

When we take this notion and expand it to countries and regions we find the basis for trade. Trade does not depend on being able to do something better than your neighbor (that would be absolute advantage). It depends on being able to do something comparatively better than your neighbor. Look at the example below. In this (imaginary) scenario, Texas can produce both cotton and rice more efficiently than Louisiana can. So why would they trade with one another?

In this example Texas has an absolute advantage in both rice and cotton. However, in order for Louisiana to increase the production of rice by 100,000 tons from, say 200,000 to 300,000 tons, they would have to give up only 50,000 tons of cotton, since the trade-off between rice and cotton is 2:1. In order for Texas to increase their production of rice by 100,000 tons, from, say 300,000 to 400,000 tons, the would have to give up 62,500 tons of cotton, since the trade-off between rice and cotton is 1.6:1 for Texas. If they are willing to trade rice for cotton at the rate of 55 tons of cotton for 100 tons of rice both can gain from trade. If Louisiana puts 100,000 tons of rice up for trade, they can get 55,000 tons of cotton from Texas gaining 5,000 tons over what they could do themselves. At the same time Texas is getting 100,000 tons of rice for only 55,000 tons of cotton gaining 7,500 tons of cotton over what they could have done themselves.

Not only does the notion of comparative advantage have power in explaining the behavior of Billy Rose and Paul Prudhomme, it provides a model through which we can understand how and why trade between individuals, regions, and countries takes place.

Exercise 2.2:
Why Isn't Mick Jagger a Practicing Economist?

Mick Jagger, lead singer of the Rolling Stones, was educated at the London School of Economics. Why, then, has he chosen to work as a singer/songwriter/producer for a band rather than as a practicing economist? The answer lies in the Principle of Comparative Advantage, which says that everyone does best when each person concentrates on the activities for which his or her opportunity cost is lowest. Mick Jagger's opportunity costs explain his choice to be part of the Rolling Stones rather than become an economist.

Mr. Jagger's opportunity cost of practicing as an economist is the benefits he receives as a member of the Rolling Stones. He receives a great deal of money, fame and presumably enjoyment from being the lead singer for the band. Giving all of it up to become an economist is quite a high opportunity cost.

On the other hand, his opportunity cost of singing with his band is the income, enjoyment and fame he would receive if he were an economist instead of a rock star. Mr. Jagger will do best if he concentrates on the activity for which his opportunity cost is lowest. It seems obvious (and his choice bears it out) that Mick Jagger's opportunity cost of doing anything besides being a singer/songwriter is very high because it means giving up his very successful and lucrative career as a rock star. His specialization in the music industry allows him to earn enough to hire the services of an economist and still be better off than if he were an economist himself.