The Law of Comparative Advantage and Opportunity Cost

•April 30, 2007 • Leave a Comment

Octavian: I will be a middling swordsman at best.
Titus Pullo: It is better to be a middling swordsman than not one at all.
Octavian: That is not true! The graveyards are full of middling swordsmen.

Octavian must have seen deeply into this. Aside from the fact that being an average swordsman will cost him his life in a battle, he must have known something about comparative advantage. What is comparative advantage anyway?

Take the following illustration for instance.

                                        Defeats a Battalion          Writes poetry about a Battalion
Marcus Aurelius                      2 hours                                 6 hours
Gaius Octavian                        4 hours                                 10 hours

Marcus Aurelius defeats a battalion in two hours while Gaius Octavian does it in four hours. When it comes to writing poetry about a battalion, Marcus Aurelius does it in six hours while Gaius Octavian in ten hours.

It seems that Marcus Aurelius has the better talent in doing either since it takes shorter time for him to do whichever. But according to the law of comparative advantage, it doesn’t necessarily have to be so.

We take a look at Marcus Aurelius for instance. If he focuses on defeating a battalion, he foregoes the opportunity of writing poetry about the battalion. In that span of two hours of defeating a battalion, he could have already written about 1/3 of a battalion. For Gaius Octavian, in his span of four hours defeating a battalion, he could have already written about 2/5 of a battalion.

On the other hand, if Marcus Aurelius focuses on writing poetry about a battalion, he foregoes the opportunity of defeating a number of battalion. More so, in that span of six hours of writing poetry about a battalion, he could have already defeated three battalions. For Marcus Octavian, in his span of ten hours of writing poetry about a battalion, he could have just defeated two and a half battalions.

Following the opportunity cost concept, which basically refers to the foregone item to produce a certain item, the one who gives up less has a comparative advantage over the other. In defeating a battalion, Marcus Aurelius gives up less battalion in poetry writing than Gaius Octavian, which means that he has the comparative advantage here. In writing poetry, it is Gaius Octavian who gives up less.

Now, if Marcus Aurelius and Gaius Octavian were your subordinates in ancient Rome, it would have been wise to assign the former to defeating a battalion and the latter to writing poetry.

Note: If the example is quite baffling, try replacing the Romans with farmers. Substitute defeating and writing with corns and rice, or something else. And the battalion, replace it with tons or cavans.


Review of the Economic Approach

•April 28, 2007 • Leave a Comment

According to “Economics: Private and Public Choice”, Economics is all about looking at what lasts or how something lasts and how everyone benefits from it. It ‘s also about making the most with what we have. 

Here are the guideposts to economic way of thinking:
1. Trade-offs are inevitable.
2. People make the most out of their limited resources.
3. Incentives matter.
4. Individuals decide at a margin.
5. Information acquisition is costly.
6. Economic decisions generate secondary effects.
7. Value is subjective.
8. The test of a theory is its ability to predict.

And here are the common pitfalls which should be avoided in the economic way of thinking:
1. violation of ceteris paribus
2. association is not causation
3. fallacy of composition

Hello world!

•April 4, 2007 • 1 Comment

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