Comparative Advantage and the Tragedy of Tasmania

What can a small, isolated island economy teach the rest of the world about the nature and causes of the wealth of nations? When Tasmania was cut off from mainland Australia, it experienced the miracle of growth in reverse, as the reduction in trade and human cooperation forced its inhabitants back to the most basic ways of living. In an economy with a greater number of participants trading goods and services, however, there are more ways to find a comparative advantage and earn more by creating the most value for others. Let's join Bob and Ann as they teach us the "Story of Comparative Advantage" like you've never seen it before.

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- [Don Bourdreaux] Let me tell you
about the island of Tasmania.

It's about 130 miles off the coast
of South Eastern Australia

A long time ago when seas were low

Tasmania was part of Australia.

During that time
the archaeological record documents

that Tasmanians fished,
and they used bone tools.

About 10,000 years ago,

rising waters cut Tasmania off
from Australia.

On at least three
at the smaller islands

the isolated human population
died out completely.

In Tasmania the four thousand
hunter-gatherers remained

with no contact with
the rest of humanity at all.

They lost technologies
they once had;

no more fishing no more bone tools;
they also missed new inventions

such as stone tools,
fishing nets, and fire

that were adopted in Australia.

When Europeans "discovered"
the Tasmanians in 1642

they found that
this extreme isolation

had created
the simplest material culture

of any people in the modern world.

Without access to other people,

some island populations shrink,
others even vanished.

Fortunately for most of us

human cooperation
has expanded over time.

As we saw in the previous videos
we enjoy enormous benefits

from specialization and trade.

One reason for this
beneficial cooperation

is what economists call
"comparative advantage."

Two things are surprising
about comparative advantage.

First, just by rearranging
who does what

we can make more stuff
through specialization and trade.

Even if no one ever gets any better
at doing any line of work.

But the second insight
is my favorite.

If you get better
at doing something

that obviously benefits you
but it also benefits me,

even though my abilities to produce
haven't changed at all.

Let me show you how this works.

It's best seen with
a simple example.

Just two people, Bob and Ann
who produce just two goods:

bananas and fish.

Here's what Bob can do
if he spends all it is time

producing only one good.

Bob can either gather 10 bananas or
he can catch 10 fish.

Ann can either get a 10 bananas
or catch 30 fish.

So let's say they each split their time

between producing
bananas and fishing.

Bob and Ann each produce
five bananas.

Bob produces five fish
and Ann produces 15 fish.

In total they produce
10 bananas and 20 fish.

You math wizards in the audience

surely see an obvious way
to increase his total.

If Bob produces just bananas
and Ann produces just fish,

then the total rises to
10 bananas and 30 fish.

So just by rearranging who does what
we get more total stuff.

You might think this outcome
is simply the result

of the division of labor
that we covered previously

but you'd be wrong.

The key insight from
the division of labor

is that workers individually
get more productive

when they specialize.

Yet in this scenario
neither Bob nor Ann

has gotten any better
at producing bananas or fish.

Just by rearranging
what tasks each does

is what made
total production increase.

The key to understanding
how this works

is opportunity cost.

Bob has to choose to gather bananas
or catch fish.

When he chooses to gather
a banana he gives up one fish

In essence Bob trades with himself.

He can use his time
to gather bananas

or trade that time to catch fish

and the cost at that trade
is one fish per banana.

That's Bob's opportunity cost.

The same holds true for Ann

but her cost of producing
one banana is three fish.

In the amount of time it takes Ann
to gather one banana

she could have caught three fish.

She trades with herself:
one banana for three fish.

So Bob only has to give up one fish
to produce one banana

but Ann must give up three fish to
produce a banana.

Ann's opportunity cost
of gathering a banana

is higher than Bob's.

She can improve her situation
if she can get bananas

for less than three fish
and Bob can improve his situation

if he can get fish for less
than one banana.

Let's say Ann trades two fish
to Bob for one banana.

They each gain.

If Ann wants a banana,
she can either gather it herself

and give up three fish
or she can catch only two fish

and then trade them to Bob.

She prefers the lower cost option
and so she trades.

Bob prefers the lower
cost option too.

Instead of giving up a whole banana
to catch a fish

he can trade that banana
for two fish.

Now he's only giving up
a half a banana for a fish.

You can see that even if Ann
is better at everything,

nothing in this story changes.

She still benefits from trade

because the number of fish
Ann gives up

to pick a banana herself
is greater than the number of fish

that she must catch and give to Bob
in order to get a banana from Bob.

Now for the insight that is
really counterintuitive.

What happens if
Ann gets better fishing.

Let's say that she can
now catch 40 fish.

Obviously that's good for Ann,

but it also means that bananas

just got more costly for Ann
to produce herself.

She would now have to
sacrifice four fish

for each banana that she gathers
by becoming a better fisherman

Ann becomes a comparatively
worse banana gatherer.

And this fact helps Bob.

The reason is that Ann
is now willing to trade

more fish for each banana
she gets from Bob.

So although Bob's ability
to produce hasn't changed

he can now get more fish
for his bananas.

Comparative advantage
is a beautiful thing.

No matter what my talents are
I can still help you

even if you are better
at everything.

The more different we are
from each other,

the more we benefit
from trading with each other.

Let's get back to the real world.

What comparative advantage
practically means for most people

is that we each spend most of our
working time at a job

that utilizes each
of our comparative talents.

How do you know what
you're comparatively good at?

What you get paid for your job
tells you that.

Comparative advantage
is the main force

driving us to use our talents
in those jobs that we do best.

It's why people who are good at math
tend to become engineers

and those who have a graphic sense
tend to go into the arts.

Specialization and trade played key roles
in the movement

from poverty to prosperity.

We would be desperately
poor without them.

But they alone do not explain
the full extent of our prosperity.

Another feature of the modern world
is important: innovationism.

Our society is an orgy
of innovations.

This innovationism would be
impossible without specialization

and trade and yet
specialization and trade

do not guarantee innovationism.

This is a topic for a future video.

Here's the current leader board of
questions submitted from our viewers.

We're going to pick a few
at the top ones

to answer with more videos.

So go and vote!

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