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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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 vanish. 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 ten 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 Anne produces

15 fish. In total they produce

ten 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
ten 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 at 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 Anne 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.

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