This is a framing practicum post. We’ll talk about what comparative advantage is, how to recognize applications of comparative advantage in the wild, and what questions to ask when you find it. Then, we’ll have a challenge to apply the idea.
Today’s challenge: come up with 3 examples of comparative advantage which you have not seen before. For each one, say what the different objectives are, and what the different components/subsystems are. They don’t need to be good, they don’t need to be useful, they just need to be novel (to you).
("What do different objectives and subcomponents have to do with comparative advantage?" I hear you ask, "I don't remember anything about that from econ 101." This is framing practicum - we want to apply the frame of comparative advantage to new kinds of systems, not just trade-between-nations or whatever. So, we're going to present it a bit differently from what you're used to.)
Expected time: ~15-30 minutes at most, including the Bonus Exercise.
What’s Comparative Advantage?
Suppose we’re running a fruit-growing company, Fruit Co, with many different orchards which can each grow apples or bananas. Each farm has different soil, different weather, different initial conditions, etc, and therefore faces different opportunity costs for growing each fruit. For instance, the Xenia site might be able to grow 1 extra unit of apples/yr at the cost of 0.5 units of bananas (by replacing their least-effective banana grove with apple trees) or vice versa, while the Yuma site may be able to grow 1 extra unit of apples/yr at the cost of 1 unit of bananas or vice versa.
Claim: given these numbers, the company can achieve a pareto increase in their fruit production. How? Well, they can produce one more unit of apples at the Xenia site (missing out on 0.5 units of bananas), and produce one less unit of apples at the Yuma site (using those resources to produce 1 extra unit of bananas). Overall, the amount of apples produced stays the same, but the amount of bananas produced increases by 0.5 units.
Intuitively: each site specializes a little more in whatever fruit they have a comparative advantage (aka relative advantage) in growing. We have multiple goals (growing more apples, and growing more bananas), and multiple subsystems which we can independently adjust to contribute to those goals (Xenia and Yuma orchards). Each subsystem faces different trade offs between the different goals, so we can make "trades" between subsystems with different trade off ratios in order to achieve pareto gains. Each subsystem specializes a little more in whatever goal their trade off ratio favors, relative to the other subsystem.
We can also add more subsystems (e.g. Zion orchards), and more goals (e.g. coconut-growing). Maybe Xenia can trade off production in ratios of 1:0.5:3 (apples:bananas:coconuts), Yuma can trade off in ratios of 1:1:2, and Zion can trade off production in ratios of 1:0.5:1. We can pick any two sites, then pick any two fruits whose ratios differ between the sites, and do exactly the same sort of “trade” as before: each site specializes a bit more in whichever of the two fruits their ratio favors, compared to the other site. For instance, we could pick Xenia/Zion and apples/coconuts: Xenia could produce 3 more units of coconuts at the cost of 1 unit of apples, and Zion could replace those apples at the cost of just 1 unit of coconuts, so overall there’s a gain of 2 coconuts.
There are two ways this sort of “trade” can’t be made:
- One site is already maximally specialized. For instance, if Zion is already fully specialized in growing apples, then there are no further banana or coconut groves to replace with apple trees.
- The two sites trade off in exactly the same ratios. For instance, Xenia and Zion both trade off apples:bananas at a ratio of 1:0.5, so we can’t achieve a pareto gain with a little more specialization in those two fruits between those two sites.
What To Look For
In general, comparative advantage should come to mind whenever we have an optimization problem with both
- Multiple goals/objectives (i.e. pareto optimality)
- Components/subsystems whose parameters can vary (approximately) independently
Note that “multiple goals” might really mean “multiple sub-goals” - e.g. Fruit Co might ultimately want to maximize profit, but producing more apples is a subgoal, producing more bananas is another subgoal, etc.
Useful Questions To Ask
In the Fruit Co example, the key question is: what are the ratios at which different sites can trade off between production of different fruits? As long as those ratios are different, we can achieve a pareto gain.
More generally, we should ask: what are the ratios at which different components/subsystems can trade off between different objectives?
Another example: suppose we’re designing a car. We have many objectives: speed, handling, cost, noise, comfort, etc. We have many subsystems which we can adjust approximately-independently: engine, transmission, body, seats, air conditioner, etc. So, we look at the ratios at which we can trade off speed:cost:noise by adjusting the engine, or the body, or the air conditioner. Can we achieve a 1-unit decrease in noise more cheaply by adjusting the engine or the air conditioner? Can we gain a bit of speed at the least noise-cost by adjusting the engine or the body? If these ratios differ, it often means we can achieve a pareto gain - e.g. maybe we can give the air conditioner team a bit of extra noise-budget (to make the air conditioner cheaper), and in exchange the engine team spends a little extra to cut back on engine noise, and that works out to a net decrease in both cost and noise.
Come up with 3 examples of comparative advantage which you have not seen before. For each one, say what the different objectives are, and what the different components/subsystems are. They don’t need to be good, they don’t need to be useful, they just need to be novel (to you).
Any answer must include at least 3 to count, and they must be novel to you. That’s the challenge. We’re here to challenge ourselves, not just review examples we already know.
However, they don’t have to be very good answers or even correct answers. Posting wrong things on the internet is scary, but a very fast way to learn, and I will enforce a high bar for kindness in responses to other peoples' answers. I will personally default to upvoting every complete answer, even if parts of it are wrong, and I encourage others to do the same.
Post your answers inside of spoiler tags. ( How do I do that? ) [EDIT: I accidentally made this a normal post rather than a question post, and now there's responses so it's a bit late to switch. Ignore the spoiler requirement for this one.]
Celebrate others’ answers. This is really important, especially for tougher questions. Sharing exercises in public is a scary experience. I don’t want people to leave this having back-chained the experience “If I go outside my comfort zone, people will look down on me”. So be generous with those upvotes. I certainly will be.
If you comment on someone else’s answers, focus on making exciting, novel ideas work — instead of tearing apart worse ideas. Yes, And is encouraged.
I will remove comments which I deem insufficiently kind, even if I believe they are valuable comments. I want people to feel encouraged to try and fail here, and that means enforcing nicer norms than usual.
If you get stuck, look for optimization problems with both:
- Multiple goals/objectives (i.e. pareto optimality)
- Components/subsystems whose parameters can vary independently
Bonus Exercise: for each of your three examples from the challenge, what are the ratios at which different components/subsystems can trade off between different objectives? I’m not looking for numerical values here, just a statement of what those “ratios” mean within the context of your particular example. How might you measure the ratios?
This bonus exercise is great blog-post fodder!