The esteemed Adam Smith, father of economics had created the theory of absolute advantage. Basically, if you can make something cheaper than anyone else, you should, and then export it.
There was a fatal flaw in the theory. What if one country was better at producing everything than another country? Should that country produce and trade all the worlds goods? Should the lesser country produce and trade nothing?
His answer took form in the theory of comparative advantage:
Here are two countries with some fictional numbers, Malaysia and Thailand. The lines show a simplified version of what the country could produce if it uses all its resources to produce palm oil or automobiles.
Here, if Malaysia directed 100% of its economy into palm oil production, it could make $100 million, or if into Automobiles, only $50 million. We can say this is because the people have better training and knowledge in palm oil production, the climate is better suited to agricultural work than industrial, favorable business policies, or a number of reasons that affect productivity.
Being a bigger country with more natural resources, in our example Thailand can make $105 million in palm oil production or $120 million in automobile production.
In this example, Thailand has absolute advantage in both. But there is no point in Malaysians sitting idle and not making anything. So comparative advantage explains that Thailand is still better off making cars and Malaysia is still better off making palm oil.
In our own life, we sometimes think that other people are better at everything than us. We get tempted to not even try. But just like Malaysia there, we need to stop comparing ourselves to others, even if they have the absolute advantage. We should look at our comparative advantage, what we do better than other things.
Here's Mary and Tom. Mary and Tom both dream of being wealthy.
Mary is a bookish person who loves using mathematics to solve problems. She knows that if she studies hard and gets a good degree, she can get a job in a finance firm paying $100,000 a year. She is not very risk taking or entrepreneurial. She could start her own accounting firm but will probably not make a lot of money from it ($50K).
Tom is one of the lucky people that seem to have academic skills and practical street smarts. He also knows he can study, get his degree and get the job Mary is going for but with a $5k a year raise. But he has a great idea for his own finance firm, and is convinced he can make more money doing this ($120K).
In this example Mary might be jealous of Tom. But it really doesn't matter. In any case, Mary will still make more money with her studies and job in a big firm than she would starting her own business. Likewise Tom will start his business.
As I've said time and again, Economics is a science of choice. Here is another example. It shows how we can get the most benefit by looking at what we do better than other things, not other people. In fact the science shows how everyone gains by all individuals seeking what they do best, their comparative advantage. And it tells us that comparing ourselves to others isn't important to realize the best gains in our life.
And as a final note, we of course have to recognize that money is not the only motivator to our lives. But whatever provides an incentive for us can be used the same way.
Here is one final graph. Is money or enjoyment more important? I'll leave you to decide what you think Tom and Mary should do with their life.
