Im my Principles of Econ class yesterday, I stole
one of John's in class activities to demonstrate the principle of comparative advantage.
I posted a short video of the students participating, but the video really shows nothing other than I know how to use the video camera on my Blackberry. In setting up the demonstration, I thought I had a complete understanding of comparative advantage, after all,
I'm an award winning serious economist. But in running through the rounds of the demonstration, I ended up giving myself a much clearer understanding of what comparative advantage means*. So I thought I would share (even if what follows is obvious to everyone else).
First some background on the experiment. In the experiment, students are divided into groups, by table in my case, which each represent a country or island or neighborhood or state or fictitious realm or whatever. Each group is allocated 100 hours of labor per round to be divided between the production of red things and black things. Labor is the only input required to produce red things and black things.
The trick to the demonstration is that the production technology (the number of hours needed to produce one red thing and one black thing) is determined by a random deal of red and black playing cards. Each group is dealt one red card and one black card from a standard deck--with face cards removed to avoid the confusion over what a J means in numbers. The number on each card represents the number of hours it takes to produce that color thing. For example, if I am dealt a 4 of hearts and a 5 of clubs, I can produce one red thing in 4 hours and one black thing in 5 hours. Some groups were very efficient at producing both (say a red 1 and a black 2) while most groups were efficient at one and less efficient at the the other. There was one group that was highly inefficient at both (red 9 and black 10). i mention that group because it plays a key role in my better understanding of comparative advantage.
In round one of the demonstration, groups have to make production decisions on their own, with no trades allowed. Everything produced will be consumed. I told them to think of it as the deserted island scenario. I threw in the requirement that in order to survive to the next round they have to consume at least three of each thing, red and black. Beyond that, groups were free to produce as much or as little of each as they want as long as they use up all 100 hours of their labor. Most groups chose a similar strategy with no trading: Produce three of the good you're less efficient at producing and then maximize production of the other color. So a group with a red 5 and a black 10 might choose to produce 3 black (30 hours) and 14 red (70 hours) using this typical strategy. When asked why they chose this strategy, many responded that it gave them the most things to consume. So far so good. Since I didn't give any real reason to prefer red over black or vice-versa, maximizing total production and consumption seems to be rational.
In round 2, countries are allowed to make one trade, but they can only trade after they make their production decisions and they can only make one trade. Next is where I made my mistake. I told them that the goal of trading is to see if they could improve on their first round outcome--that is consume more red and more black than they did in round 1. While more consumption of both is a possible consequence of trade, it turns out that's really not the point. In some cases, countries were able to find a trade that made them better off as I defined it, but in others, they weren't. I was puzzled and thinking that I had a lot of work to do with these students. Trade should be able to make everyone better off.
So I encouraged everyone to trade for another round but with different partners. And I got the same result. Some were better off, some weren't. And there was one group who nobody wanted to trade with; the highly inefficient group (9 red and 10 black). That's when I started thinking that maybe I wasn't thinking about this the right way. The principle of comparative advantage says that even if a country is highly inefficient at producing everything, there should still be opportunities for gains from trade. Maybe I needed to reconsider what I meant by gains?
So in the next round I assigned trading partners based on proximity (the closest table) and I told them that they had to make a trade, but I wanted them to trade in such a way that they consumed a bundle of red and black that they couldn't have produced on their own. That is, the bundle they consume would have to take them more than 100 hours to produce if they produced it on their own. That's when it clicked.
Immediately, groups started to realize that they would have to produce the thing they were best at producing and then trade for what they needed of the other. If two groups were better at producing red than black, then the one who had to give up the least black to produce one red would produce red and the other would produce black. Within a minute or two, all of the groups had found an acceptable trade, including the group that was bad at producing both things.
Once they had their trades complete I asked them to calculate the number of hours it would have taken them to produce everything they consume--keeping in mind that it took a combined 200 hours to produce everything consumed by each pair of countries. The lowest total equivalent hours of consumption we had was 240 hours and the largest was over 300, and every group was now consuming more than 100 hours worth of red and black. In other words, through specialization and trade, we were able to expand total production/consumption by 20-50% over what could have been consumed without trade.
That's comparative advantage.
*One of the biggest benefits of teaching is that I really learn what I thought I knew.
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Moraleja: El mensaje principal está allí: el comercio bajo ventaja comparativa funciona como una expansión del conjunto factible global por encima de la suma de las partes... (en el ejemplo, noten que la solución de comercio permite que la "economía global" del salón de clase produzca una asignación con las 200 horas de dotacion global del factor escaso que hubiera requerido 240 horas globales para producirse autárquicamente... Además de esta expansión global, la asignación consumida por cada economía local en la asignación de comercio resulta no factible con los recursos locales... En otras palabras, la asignación consumida con comercio por todas las regiones es no factible sin comercio. O sea que hay ganancias de comercio para todos...)
