Cutting the diamond of comparative advantage.
Hobbs, Bradley K. ; Segal, Gerald J.
INTRODUCTION
David Ricardo left economists an intellectual legacy upon which the
foundation for mutually advantageous trade rests. Comparative advantage
stands as a monument not only to Ricardo, but also to the practice and
methods of economics itself. In our attempts to help students to
appreciate and embrace the principles of economics, teaching comparative
advantage represents a splendid opportunity to display the logical
method and power of economic theory.
The ramifications of comparative advantage on the overall levels of
efficiency and wealth of an economy are well known to economists.
Voluntary transactions based upon relative efficiencies in production
serve to allocate resources more efficiently in a market economy. The
populace of a modern democracy with an advanced, industrialized economy
can ill-afford to ignore the advantages that accrue through
specialization and exchange. Unfortunately, it is our observation that
students often fail to understand comparative advantage as an important
economic principle underlying the intellectual foundation for gains from
trade. Another important reason to dispel confusion is that comparative
advantage remains as a fundamental intellectual bulwark against
protectionism. As nations continue to expand their roles in the
international economy, an educated populace must understand the
tradeoffs that are made when any trading entity chooses to forgo trade.
The predominant method of presenting comparative advantage is based
upon a labor per unit of output approach. In Ricardo's original
work and in many leading undergraduate texts the first exposure to
absolute and comparative advantage is often based upon this reference to
labor productivity. It is our experience that students are easily
confused in their initial exposure to comparative advantage due to the
implicit reference to labor productivity inherent to the analysis. An
alternative approach is to couch the initial exposure to absolute and
comparative advantage--simply and directly--in terms of opportunity
costs. This method is based upon the number of units of output per unit
of labor and it links more directly to the conceptual foundations of the
production possibilities curve. The logical difference is, for
professional economists, a matter of simple conversion. However, we
maintain that the pedagogical effects are significant.
The advantages of the alternative approach (output per unit of
labor) are numerous. First, the output per unit of labor is firmly
anchored in an even more fundamental principle in economics--opportunity
costs. Opportunity costs are intuitively understood, lively examples
abound, and students are able to relate their calculations to their
personal experiences. Second, the approach directly incorporates a
graphical exposition of the production possibilities curve. The
complementarities between verbal and visual approaches are well
documented. Saunders and Walstad (1990) provide a concise summary
discussion of the relationship between visual and verbal modes of
information processing in Chapter 7--Learning Theory and Instructional
Objectives.
Third, it is less obtuse to students. We have found that the
approach better provides the opportunity to help students to understand
the inevitable tradeoff between realism and applicability: a problem
that haunts economics in the minds of many university and college
students. Fourth, the approach begs a discussion of the labor per unit
of output approach and does nothing to hinder a subsequent presentation
of it. Fifth, and most importantly, it is our observation that students
more clearly understand comparative advantage their retention of the
principle and their ability to transfer it are improved.
An example of the method by which comparative advantage is
presented under the output per unit of labor approach follows: Sue and
Bert are going to throw a party and the menu consists of pizza and ice
cream sundaes. First, we construct a matrix (figure 1) which presents
the basic production information. The numbers within the matrix
represent the quantity of items which each can produce using one unit of
labor; in this case one hour. The matrix is clearly labeled as output
per unit of labor and a brief explanation concerning the choice of labor
unit ensues--e.g., any labor unit can be used so long as both parties
use the same measure.
Based upon the information in the matrix, Sue can produce either 3
pizzas or 4 sundaes and Bert can produce either 2 pizzas or 6 sundaes.
Absolute advantage can be easily explained at this point. If Sue can
produce three pizzas and Bert can produce only two, a direct comparison
of the production capabilities of each reveals that Sue ought to produce
pizza. If Sue can produce four sundaes whereas Bert can produce six,
then a direct comparison of the production capabilities of each reveals
that Bert ought to produce sundaes. Students are then asked to determine
the trading patterns using the following production information. This is
an exercise that lends itself well to a small group discussion context.
For pizzas, the production information is the same. Hence, there is
no change in the production assignment. In the case of sundaes, however,
a dilemma is presented, for the assignment of production is
indeterminate under absolute advantage. Because absolute advantage is
determined by external costs, and we are looking at the producible
commodity across trading entities, we have yet in incorporate internal,
domestic, or opportunity costs. To make a comparison based upon
opportunity costs requires students to use comparative rather than
absolute advantage.
In order to determine trading patterns, we must investigate
foregone opportunities within each trading entity based upon internal or
domestic costs. Students are reminded that under the concept of
opportunity cost, the decision to use one's time to produce pizzas
is, after all, simultaneously a decision to not produce sundaes and vice
versa. The tradeoff can be made quite explicit by the graphical
presentation of the matrix information revealing a constant cost
production possibilities curve. Students are reminded that the
production possibilities curve for each trading entity holds constant
the quantity of resources--specifically the one unit (hour, day, week,
etc.) of labor.
Bert and Sue now decide to divide the work associated with their
party based upon the principle of comparative advantage. Because each
measurement is based upon the same labor unit, we can present their
production decision in the following manner.
Sue Bert
3 pizzas = 6 sundaes 2 pizzas = 6 sundaes
or or
3/3 pizzas = 6/3 sundaes 2/2 pizzas = 6/2 sundaes
or or
1 pizza = 2 sundaes 1 pizza = 3 sundaes
Reducing the equation in terms of pizza yields the fact that in the
time Sue could make one pizza she must forgo the production of two
sundaes, i.e., the production of one pizza has an opportunity cost of
two sundaes. For Bert, the production of one pizza has an opportunity
cost of three sundaes; in the amount of time Bert can make one pizza he
must forgo the three sundaes he could have produced. If Sue must forgo
two sundaes for producing one pizza whereas Bert must forgo three, then
Sue is obviously the low-cost producer of pizzas. It would certainly be
to their advantage to be giving up two sundaes rather than three sundaes
for each pizza made.
What about the sundaes?
Sue Bert
6 sundaes = 3 pizzas 6 sundaes = 2 pizzas
or or
6/6 sundaes = 3/6 pizzas 6/6 sundaes = 2/6 pizzas
or or
1 sundae = 1/2 pizza 1 sundae = 1/3 pizza
Reducing this equation yields the fact that producing one sundae
has an opportunity cost of one-half of a pizza for Sue--in the time she
can make one sundae she must forgo the production of one-half of a
pizza. For Bert, the opportunity cost of producing one sundae is
one-third of a pizza. If the cost to Sue of producing one sundae is 1/2
of a pizza while the cost of Bert producing one sundae is 1/3 of a
pizza, then Bert is clearly the low opportunity cost producer. It would
certainly be to their advantage to be giving up 1/3 of a pizza per
sundae as opposed to giving up 1/2 of a pizza per sundae.
A number of other aspects can be easily incorporated into the
discussion at this point. Nearly always included are: the irrelevance of
the labor or trading unit chosen, the symmetry of the calculations for
each party, and the political economy of trade. The later category
offers two clear opportunities from a pedagogical perspective. First,
one can easily address the multitude of issues that enter into
real-world trade negotiations. Bargaining theory, international
relations, public choice issues, and resistance to trade by some groups
are all topics deserving discussion. Second, these topics nearly always
act as a conduit into current issues that face our political
decision-makers; hence, the discussion often taps into the
students' existing "learning set".
Students can then be asked to determine exactly how many units of
output Bert and Sue would need for their party. Regardless of the
numbers chosen, it can always be shown that following comparative
advantage is superior to its violation. For example, suppose that Sue
and Bert have determined that they will need six pizzas and eighteen
sundaes. Following comparative advantage, we would assign Sue the task
of making pizzas and Bert the task of making sundaes. Sue would produce
the six pizzas in two hours, and Bert would produce the eighteen sundaes
in three hours. Thus, they spend five labor hours in preparation for the
party. If we violate comparative advantage and have Bert make the pizzas
and Sue make the sundaes, the preparation takes three and three hours
respectively they will spend six hours performing the exact same task.
At times, students have questioned the "fairness" of the
one-sided reduction in work effort. This can be treated as an
opportunity to discuss the welfare implications of the principle of
comparative advantage. When economists speak of the gains from trade,
those gains accrue to the society--to the community as a whole. While
there can be winners and losers at the sub-societal level, in a world of
scarcity, the collective "we" can only benefit from trade.
Certainly, a cursory review of trade negotiations points to the
inevitability of issues of distribution being considered--but it also
seems clear that comparative advantage is important enough to be
considered on its own grounds--namely, the efficacy of an economic
system.
Numerous extensions of comparative advantage are possible. The
horizontal expansion of the production information matrix allows one to
demonstrate decreasing and increasing costs. Implicit assumptions
concerning subjects such as the employment levels and homogeneity of
factors, varying cost conditions, and the labor theory of value impact
the analysis and can be made explicit. Though, it is our experience that
from a pedagogical perspective, it is better to address these issues in
subsequent treatments of the relationships between these issues and
comparative advantage. For instance, in one of the author's
International Economics course, after absolute advantage is presented,
he often produces a list of major problems and resolutions in turn.
First, absolute advantage fails to provide a consistent explanation of
trade patterns when one trading entity has the advantage in both
products. Resorting to opportunity costs and comparative advantage
solves this problem. Second, constant costs produce horizontal cost
curves and complete specialization, which are unrealistic. This can be
addressed through the introduction of the influence of the shapes of
cost curves on trading patterns incorporating isoquant analysis and
current theoretical discussions on the role of increasing costs. Third,
the calculations are based solely on cost conditions: we are implicitly
accepting the labor theory of value. Consistent use of the matrix
approach allows one to easily extend the discussion to incorporate the
average cost of production approach that is mutually determined by cost
and demand conditions. In addition, the homogeneity of labor can be
dropped as an assumption in this step. In international trade courses,
the influence of exchange rates upon trading patterns can easily be made
explicit.
A brief review of leading undergraduate textbooks reveals that a
majority present comparative advantage using the labor per unit of
output approach. One obvious research project would be to compare the
effects of pedagogical approach on subsequent student knowledge of
comparative advantage. Given that students face at least two sources of
information in each course--the textbook and the professor--one would
have to control for the approach of each. The widespread existence of
standardized tests of economic knowledge (the Test of Understanding in
College Economics) could be incorporated to test both short-term and
long-term retention of the principle.
Another interesting research project would be to compare attitudes
towards free trade, pre--and post-comparative advantage exposure. Again,
controlling for the method of approach at the textbook and professor
level would be important. Ultimately, if we are successful in teaching
comparative advantage, its importance and relevance ought to be
reflected in the attitudes of those exposed to its implications.
Though recent developments in international trade theory have
attacked the static nature of Ricardian comparative advantage, a clear
reading of this literature indicates that the crucial questions involve
the conflict between static and dynamic analysis and the role of
government intervention in the international trading system. It is not a
question of whether or not comparative advantage is relevant. Krugman
(1992) makes a strong case for continued use of comparative advantage
for its relative simplicity and for its predictive power. As a
fundamental principle of economics, comparative advantage remains as one
of the transcendent conclusions of economic logic with wide-ranging
ramifications.
Current curricular reform movements call for rethinking traditional
teaching methods and an increased awareness of economic knowledge among
our populace. The area of international relations and international
trade is often cited as one of particular concern for American students.
Ignorance of the gains from trade and the concept of comparative
advantage does not bode well for us in an era of increasing
international economic activity.
As economists, it is important to subject our teaching methods to
our cost-benefit criterion, in the attempt to increase pedagogical
effectiveness. This paper calls for a specific and progressive order of
approach in teaching the principle of comparative advantage, which is
designed to increase student comprehension. It incorporates previously
developed principles and tools, opportunity costs and the production
possibilities curve, as anchors for student learning. It is also
designed to allow for the subsequent relaxation of restrictive
assumptions while making clear that specialization and trade lead to
gains from the societal perspective.
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Bradley K. Hobbs, Florida Gulf Coast University
Gerald J. Segal, Florida Gulf Coast University
Figure 1: Output per unit of Labor
Pizza Sundaes
Sue 3.00 4.00
Bert 2.00 6.00
Figure 2: Output per unit of Labor
Pizza Sundaes
Sue 3.00 6.00
Bert 2.00 6.00
