Recently, I have been reading Gregory Mankiw’s Principles of Economics and found it quite interesting. Here, I want to share one example: trade can benefit both parties, creating a win-win situation, rather than one side succeeding and the other failing.
Fable Story
Assume there are only two people and only two goods. One is a farmer, and the other is a fisherman. The goods are fish and rice. Both can fish and farm, but their efficiencies differ. Suppose that in one year, if the farmer only farms, he can produce 480 kg of rice; if he only fishes, he can catch 240 kg of fish. The fisherman, if only farming, can produce 160 kg of rice; if only fishing, can produce 160 kg of fish.
Question
In this situation, since the farmer is more efficient than the fisherman in every aspect, is trade unnecessary?
Answer
The answer is no.
Trade
Suppose the farmer spends half the time farming and half the time fishing. Then he can obtain 240 kg of rice and 120 kg of fish. The fisherman can get 80 kg of rice and 80 kg of fish.
But if the farmer spends 3/4 of his time farming and 1/4 fishing, while the fisherman spends all his time fishing, then the farmer trades 90 kg of rice for 70 kg of fish.
Finally, the farmer will have (480 \times \frac{3}{4} - 90 = 270) kg of rice and (240 \times \frac{1}{4} + 70 = 130) kg of fish, while the fisherman will have 90 kg of rice and (160 - 70 = 90) kg of fish.
The farmer gains an extra 30 kg of rice and 10 kg of fish, while the fisherman gains an extra 10 kg of rice and 10 kg of fish.
Explanation
As we can see, even though the farmer is absolutely more efficient than the fisherman in both farming and fishing, by trading without increasing their total work time, both parties achieve better outcomes than before. This involves the economic concept of opportunity cost, which is what one gives up to obtain something else.
For the farmer, the opportunity cost of 1 kg of fish is ( \frac{480}{240} = 2 ) kg of rice, while for the fisherman, the opportunity cost of 1 kg of fish is ( \frac{160}{160} = 1 ) kg of rice. Therefore, the fisherman has a comparative advantage in producing fish. Although the farmer has an absolute efficiency advantage, the fisherman has a greater relative advantage. With reasonable trade, the fisherman dedicating all time to fishing results in a win-win situation.
Summary
Though this is a simple example, it is very important for understanding why as society develops and specialization becomes clearer, efficiency greatly increases.
It also helps explain why, even though the United States leads in both agriculture and industry, it can still improve Americans’ living standards through trade.
