Yesterday’s pop quiz posed this question:
Suppose that an acre of land in Iowa can yield either 50 bushels of wheat or 100 bushels of corn, while an acre of land in Oklahoma can yield either 20 bushels of wheat or 30 bushels of corn.
Which state has the comparative advantage in growing wheat? Which state has the comparative advantage in growing corn?
Suppose the residents of each state consume 200 bushels of wheat and 360 bushels of corn. If, instead of pursuing policies of self-sufficiency, each state specializes in its area of comparative advantage, how many acres of Iowa and Oklahoma farmland are freed up for other uses?
Quite a few people got this right in comments. In Iowa, the opportunity cost of a bushel of wheat is 2 bushels of corn. In Oklahoma, the opportunity cost of a bushel of wheat is 3/2 bushels of corn. Becauses 3/2 is less than 2, Oklahoma is the low-cost wheat producer, which is the same thing as saying that Oklahoma has the comparative advantage in wheat.
For a bushel of corn, the opportunity cost is 1/2 bushel of wheat in Iowa or 2/3 bushels of wheat in Oklahoma. Because 1/2 is less than 2/3, Iowa is the low-cost corn producer, which is the same thing as saying that Iowa has the comparative advantage in corn.
Knowing the comparative advantages tells us, without any further computation, that everyone can be richer if Oklahoma exports wheat and Iowa exports corn. But if we choose to do the extra computation, we see that with self-sufficiency, Iowa needs 7.6 acres to feed its people and Oklahoma needs 22 acres. whereas if Iowa grows enough corn for both states and Oklahoma grows enough wheat for both states, then Iowa needs only 7.2 acres and Oklahoma needs only 20 acres. The remaining acres are available to feed even more people, or to build NASCAR tracks.
(Edited to add: It was pointed out in comments that in the first couple paragraphs of this answer, I said “corn” when I meant wheat and vice versa. This is, I think, fixed now. Very sorry for not proofreading better.)
This example is ultra-simplistic in several ways of which here are two:
- It assumes that the yield in either state is a simple multiple of the number of acres under cultivation—in other words, we (unrealistically) assumed away diminishing returns.
- It assumes that food consumption in each state is fixed, as opposed to varying with price.
Econonerds might recognize that these assumptions are tantamount to assuming that all supply curves are horizontal and all demand curves are vertical.
But do not make the mistake of dismissing the example because of its simplicity. As I tell my students, you can’t understand the hard stuff till you’ve mastered the easy stuff. And as those students progress to more difficult and realistic exercises, they come to realize that the underlying logic remains pretty much inescapable—compute the comparative advantages, and you will discover an opportunity for everyone to gain from trade.