As we dig into the fall semester, thousands of students will begin their first economics courses and be exposed to the world of economic thinking. I used to be a drum teacher at a music company. Something I enjoyed doing as a teacher was leaving the student with the ability to play and practice a full, simple drum pattern after the very first lesson, like the main beat to AC/DC’s. Back to Black or The Beatles’ The Yellow Submarine.
Having decided on the life of an economist, I like to think about what would be a good first course in economics. What economic thinking activity can students use after their first course?
One of my favorite early lessons is an exercise with the idea of positive comparison. This concept explains a lot about the world in a very simple sense, but that can be confusing to a beginner reader. It explains why people exchange with each other in the first place.
Years ago, I had a conversation with another drum teacher. I said that I was focusing my attention on economics in graduate school. “Oh,” he said in agreement, “I once took an undergraduate class in economics. I don’t remember much, but I learned how to pay my taxes.” I nodded along with him, although inside I was worried.
However, one should not learn to do taxes in an economics class. The first step should be understanding why do so many people pay others to do their taxes for them. The reason is comparative advantage.
Professors often illustrate this with the hypothetical trade of coconuts and bananas on a desert island or the trade of cloth and wine between Britain and Portugal. Here is an example I would like to give to my friend, a drum teacher. I believe it provides an excellent introductory course for economics students.
Imagine an economy with only two people and two goods: music and accounting services (we are led to believe that citizens in this economy can survive on these two goods alone). We also say that during each day, a person has a certain capacity to produce any of these goods in different quantities.
Our two people, Brutto and Bella, are unique in their ability to produce. If Brutto focuses all his energy on accounting services, he can produce 5 units. If he concentrates on music he can produce ten songs. Bella, on the other hand, is very productive. If he focuses on accounting, he can do 10 units, and if he spends his time only on music, he can produce 30 hits.
Here is their production capacity, showing some of the piles they can produce with autarky:
Brutto and Bella’s Skills in Song Production or Same Day Accounting Services
| Gross | Bella | ||
| Songs | Financial Services | Songs | Financial Services |
| 0 | 5 | 30 | 0 |
| 2 | 4 | 27 | 1 |
| 4 | 3 | 24 | 2 |
| 6 | 2 | 21 | 3 |
| 8 | 1 | 18 | 4 |
| 10 | 0 | 15 | 5 |
| – | – | 12 | 6 |
| – | – | 9 | 7 |
| – | – | 6 | 8 |
| – | – | 3 | 9 |
| – | – | 0 | 10 |
For some strange reason, Bella has been given a great opportunity to consume both goods. He has an absolute advantage over Brutto. It seems, Brutto could use some help from Bella, but Bella doesn’t need Brutto.
One should note, that at a production rate of 30 S per 10 A, it costs Bella 3 songs every time she produces a unit of accounting services. It costs only 2 Brutto. When Bella produces one song, she gives up only 1/3 of a unit of accounting services, while Butto gives up 1/2 of a unit. Brutto can agree to trade a count service for any number of songs greater than 2, and Bella can agree to trade a song for any number of count services greater than 1/3.
If both Bella and Brutto are rational and willing to trade, there is a possibility that both will become rich because Bella has a comparative advantage in producing songs and Brutto has a comparative advantage in producing accounting services. The range of exchange rates that would make them better is anywhere between 2 and 3 S per 1 A. We can assume that they get a price of 2.5 S per A.
Here is a list of what the distribution of goods in this economy would look like without trade between these two people.
Music Production and Accounting Without Trading and Trading Price 2.5 S / 1 A
| Gross | Bella | ||||||
| Without Trade | By Trade | Without Trade | By Trade | ||||
| Songs | Financial Services | Songs | Financial accounting
Services |
Songs | Financial accounting
Service |
Songs | Financial accounting
Services |
| 0 | 5 | 0 | 5 | 30 | 0 | 30 | 0 |
| 2 | 4 | 2.5 | 4 | 27 | 1 | 27.5 | 1 |
| 4 | 3 | 5 | 3 | 24 | 2 | 25 | 2 |
| 6 | 2 | 7.5 | 2 | 21 | 3 | 22.5 | 3 |
| 8 | 1 | 10 | 1 | 18 | 4 | 20 | 4 |
| 10 | 0 | 12.5 | 0 | 15 | 5 | 17.5 | 5 |
| – | – | – | – | 12 | 6 | 15 | 6 |
| – | – | – | – | 9 | 7 | 12.5 | 7 |
| – | – | – | – | 6 | 8 | 10 | 8 |
| – | – | – | – | 3 | 9 | 7.5 | 9 |
| – | – | – | – | 0 | 10 | 5 | 10 |
When the trade takes place, both Bella and Brutto reach higher levels of consumption. Even though Bella is better at everything, she can still get rich by trading with Brutto. In fact, even if Bella becomes more skilled, they can still benefit from the trade.
Now imagine that Bella is involved in investing. He spends time practicing and getting better at producing songs. Now he can produce 40 songs in one day if he concentrates his energy on music. This large production of songs makes accounting services relatively scarce, and Bella is willing to give up a song for anything greater than 1/4 unit of accounting services.
If the price is renegotiated, it may arrive at a new price. Here’s what happens to trading opportunities when they reach a new value of 3.5 S per 1 A.
Music Production and Accounting Without Trading and Trading Price 3.5 S / 1 A
| Gross | Bella | ||||||
| Without Trade | By Trade | Without Trade | By Trade | ||||
| Songs | Financial Services | Songs | Financial accounting
Services |
Songs | Financial accounting
Service |
Songs | Financial accounting
Services |
| 0 | 5 | 0 | 5 | 40 | 0 | 40 | 0 |
| 2 | 4 | 3.5 | 4 | 36 | 1 | 36.5 | 1 |
| 4 | 3 | 7 | 3 | 32 | 2 | 33 | 2 |
| 6 | 2 | 10.5 | 2 | 28 | 3 | 29.5 | 3 |
| 8 | 1 | 14 | 1 | 24 | 4 | 26 | 4 |
| 10 | 0 | 17.5 | 0 | 20 | 5 | 22.5 | 5 |
| – | – | – | – | 16 | 6 | 19 | 6 |
| – | – | – | – | 12 | 7 | 15.5 | 7 |
| – | – | – | – | 8 | 8 | 12 | 8 |
| – | – | – | – | 4 | 9 | 8.5 | 9 |
| – | – | – | – | 0 | 10 | 5 | 10 |
When Bella gets better at producing songs, not only is she richer, but Brutto is richer than ever! This is where the “ah-ha” moment begins for some students.
This example involves many considerations, including the bargaining power of these two people. The numbers are chosen because they will work in this example. Some numbers may not suggest a trading opportunity. For example, trading only works here because Bella and Brutto are different.
However, this work provides a powerful reason why accountants and musicians specialize in their respective professions, and why we diverse people in society are so willing to trade one thing for another: because it makes us rich.
In addition, people can change their comparative advantage by investing in physical or human capital. That’s exactly why most students are in college to begin with: to develop talent toward a new career path and improve their future income and satisfaction. This is a proper first lesson in economics, not how to do your taxes.
Giorgio Castiglia is the Manager of the Competitive Work Program at the Mercatus Center, and a PhD student in economics at George Mason University.
Source link