Interesting Post on Comparative Advantage, and Awesome Equations at “What’s Your Formula”

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Economist: This week in comparative advantage

Even if Iga is better than Og at both fishing and fruit gathering —

— It takes Og 3 hours to catch a fish and would take 4 hours for him to gather some fruit,

— While it only takes Iga 1 hour to gather some fruit, and 2 hours to catch a fish,

Then is still pays for Iga to get her fish from Og. She could gather 2 meals of fruit and swap one of them for Og’s second fish.

Because that way Iga works only 2 hours for a meal of fruit and fish, instead of 3 if she was self-sufficient, and Og only works 6 hours, instead of 7 if he was self-sufficient.

Here’s are their budget lines:

On their own:

Og: 3hours*1 fish + 4hours*1 fruit=7 hours for 1 fruit 1 fish

Iga: 1hour*1 fruit + 2hours*1fish=3 hours for 1 fruit 1 fish

Iga should spend 2 hours to get 2 fruits

Og should spend 6 hours to get two fish.

Iga trades 1 fruit to Og in return for 1 fish.

Iga now gets 1 fruit 1 fish for 4 hours instead of 7 hours.

Og now gets 1 fruit 1 fish for 2 hours instead of 3 hours.

They are both better off (of course, why would they trade if they weren’t both better off?)

This example is great for showing reasons why people trade; mutual benefits, creating surplus. Of course Iga and Og could bargain over how the surplus should be carved up, that would be easier in a situation dealing with money instead of straight bartering. There are so many factors involved in deals/trades; timing, inventories to incorporate, interest rates, pending and planned product lines, capital structures, deciding who should bear what risk, who will reap certain potential rewards, etc. Interesting stuff, especially when deciding how to factor in, allocate, and price risk. Who might benefit the most, who might get stuck holding the bag?

The example given and the random formula in the picture above are from the awesome “What’s Your Formula” website as cited in the Economist blog post.

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