Gains From Trade - Why Ringo played the drums

You're listening to Think Like an Economist, a Himalaya Learning Production. For exclusive content like bonus episodes and supplemental materials for this podcast and others like it, go to Himalaya.com slash econ and enter promo code ECON, E-C-O-N at checkout to get your first 14 days free. It's time to think like an economist. The Beatles were pros at thinking like economists. The Beatles? Yes, haven't you heard how they used comparative advantage to their, well, advantage? And what can the Beatles teach us about economics? Well there's a legendary story that at the height of their fame, someone asked John Lennon if Ringo Starr was the best drummer in the world. He's not the best drummer in the Beatles, Lennon replied. That's because Paul McCartney was also an excellent drummer. So you'd think maybe Paul should have been the drummer instead given he was so good, but he was also a really good bass player and he was a great singer too. So it made sense for Paul to focus on playing bass and singing instead of playing the drums. Now this is a rumored story, so we don't know if John Lennon actually said these words, but it doesn't really matter because it still teaches us a great economics lesson. And it's related to opportunity costs. The opportunity cost is about or what? So I guess what would each member of the Beatles be doing if they weren't playing their instrument? Exactly. Ringo played the drums. If Ringo hadn't played the drums, well, he wouldn't have been a Beatle. If Paul had played the drums, then the Beatles would have lost a great bass player and singer. OK, so in the Beatles, the opportunity cost of playing drums was lowest for Ringo as he wouldn't be playing anything else if not drumming. So you're saying that it made sense for Ringo to drum? Yes. This is the idea we call comparative advantage. We'll be exploring it in this week's episode of Think Like an Economist. I'm Justin Wolfers. And I'm Betsy Stevenson. And we're teaching you the tools of economics to help transform your life. As ever, Naz Turan Tavakoli-Farr joins us. Betsy, Justin, aside from learning how to choose the best lineup for your band, what are we looking at today? We're doing the same thing the Beatles were doing. We're trying to figure out how best to allocate tasks. If we can figure out how to assign each task so that it's done at the lowest opportunity cost, then we'll be able to get more done. If you step back and think really hard about it, you'll see that markets are all about reallocating tasks so that each is done by the right person for the job. If we get this right, then we can produce more stuff or better stuff without working any harder. Economists call this gains from trade because it's the benefit that follows from trading tasks. And as we've seen with the Beatles, the right person for a job is not necessarily the person who's best at that job. Exactly. So let's start with an easy example. We have two kids, Matilda and Oliver, and they feed our pets. The kids, truth is, they spill the dog food and scatter the kitten chow across the kitchen and it takes them ages to get the pets fed and the mess cleaned up. But we still get them to feed the pets, even though Betsy and I could have done it quicker. Okay, so part of this is about parenting and instilling good values. They got to do some jobs. But part of it's also about economics. It's all about the opportunity cost principle. So the opportunity cost of one of you feeding the dog is that you could be making podcasts about economics, writing textbooks about economics, teaching economics. I assume your kids can't do these things. Not yet. Their opportunity cost of feeding the dog is they could be reading a book or playing a game. So it makes sense for them to do those small tasks around the house, whilst Betsy and I concentrate on the more complicated household tasks and teaching economics. The opportunity cost of feeding the pets is lower for our kids. So they do those small tasks. This is called comparative advantage. It's the ability to do a task at a lower opportunity cost. And Matilda and Oliver have a comparative advantage when it comes to feeding the cat and dog. This is different than absolute advantage, which is defined as the ability to do the job better or faster. Betsy and I have the absolute advantage here. Yes, so you two do a better job of feeding the pets. So you have the absolute advantage, but the opportunity cost of feeding the pets is lower for your kids. So they have the comparative advantage. And the person with a comparative advantage should do the job. That's because the opportunity cost is the best way of measuring the actual resources that are being used. That's why in the Beatles, Ringo played the drums, freeing up the superb drummer, Paul, to focus on playing the bass and singing. Things that Ringo really wasn't very good at. Don't forget the classic Octopus's Garden, which Ringo sang. But let's not get a rivalry going between the remaining living Beatles. Basically, it sounds like you're talking about something I love, and that's delegating. I passionately believe in it. I think people don't delegate enough because they say, it's okay, I can do this thing. But is it worth their time to do that thing if they can do something else better? Yes, comparative advantage is all about figuring out how to delegate well. It lets us focus our time on tasks where we have a comparative advantage. And that's really what markets are based on. So I can see how this works in the example you gave around your house and around how I like to delegate tasks. How do we see this in markets though? Well, Naz, do you tend to buy your lunch or do you make it? If I have a busy day at work, then I'll definitely buy my lunch. And that makes sense, right? The time you'd be spending making lunch, you could spend making podcasts about the economy. But what if I'm a good cook? You don't know if I am or not. You may be a great cook, Naz, I don't doubt it. But I think you're really great at making economics podcasts. Think about it like this. There are two ways you can make your lunch. The first is that you can buy bread and fillings and make a sandwich in your kitchen, and it might take you an extra hour each week. The second is you can spend an extra half hour each week producing podcasts and take the money you get paid for that work and use it to buy a sandwich. If it costs you fewer minutes the second way, then you're saving time and being more efficient. So it sounds like you're saying I should focus on what I'm best at and pay for the rest. Pretty much. And that's really what trade is about. You should spend more time making podcasts while someone else spends more time making sandwiches. By getting the important work of both sandwich and podcast making done by the person who can do it at the lowest opportunity costs, you both benefit. Hence the term gains from trade. So let's think through some other examples. Naz, who washes your hair when you go to the hair salon? Is it the hairstylist or an assistant? It's usually an assistant and not the hairstylist themselves. Yes, that's because the hairstylist can either wash people's hair or cut their hair. They get paid a lot more for cutting hair. So the opportunity cost of them washing hair, the or what they would be doing if they weren't washing hair, is to cut people's hair and to make more money doing so. Whereas an assistant can't cut people's hair. Their opportunity cost for washing hair is lower and so the assistant washes your hair. Or another good example is actors. Naz, you must know that the biggest stars don't do their own stunts. Yes, and I assume that's because they don't want to get hurt or something about it costing a lot of money if they get injured doing dangerous stunts. That's it. If someone's a huge Hollywood star making millions of dollars per movie and they get injured through doing their own stunts, well, they'll miss out on a lot of money while they sit out to recover. The opportunity cost of a stunt double doing the stunts is much lower, which is why big stars use comparative advantage and use stunt doubles. Let's do some more examples so we can really get to grips with this. Sure, we can go back to our household where I sort out the bills. Hey, I do tech support. So I assume Betsy is better at bills and Justin is better at tech-related stuff. Not necessarily, Naz. Look, Justin is pretty capable at sorting out the bills and managing the money, and I can do the tech stuff just fine if needs be. So you can both do everything, so why don't you? It comes back to comparative advantage. We each want to focus our time on the best use. I can do the bills and the IT, and the truth is, if I did both, it would take longer than if Betsy did both the bills and the IT. Does this mean that Betsy should do everything? Absolutely not! We can both spend around the same amount of time doing tech support each week. However, Betsy's a lot faster with the bills. Therefore, she has a comparative advantage in doing the bills, and I have a comparative advantage in doing the tech support. So I'm Paul McCartney, the Justin's Ringo star. So it's like a market. Justin focuses on the tech support in exchange for Betsy focusing on the bills. Both allow us to each specialize according to our comparative advantage. This logic works even if Justin and I don't know each other. In that case, I could sell my accounting skills, and with the money I make, I could hire Justin for his IT support skills. Remember, we should focus on doing tasks or jobs where our opportunity cost is low. The opportunity cost is lower for me to do the IT support, and the opportunity cost is lower for Betsy to manage the money. By focusing on what we both have comparative advantages over, we both gain from trading. And hence, the term gains from trade. So we're expanding this concept from your house to the economy, which is kind of cool. Let's go one step further. Let's say Justin and I draw a line down our house. My part of the house is called Betsy Land. Hey, my side of the house is Justin Land. I, as Justin Land, can sell my IT services to Betsy Land. And she, as Betsy Land, can sell her accounting services to Justin Land. You may be able to see where I'm going with this. Betsy Land and Justin Land sound like countries. Bingo! And that invisible line is basically a border. Now we've just introduced international trade into the mix. Let's extend the concept. Let's call Betsy Land the USA and Justin Land Australia. And that's exactly what happens. Americans tend to focus on producing those goods and services where they have a comparative advantage and they sell them to willing customers, including some who are in Australia. Likewise, Australians focus on producing the goods and services where they have a comparative advantage, possibly even selling them to customers in the United States. And so folks in the US and folks in Australia both benefit from doing this. We each can get our accounting and IT work done at the lowest possible opportunity cost. As a result, people in both countries use fewer resources to get their work done, which means that we can make more stuff, provide more services or work less hard. So trading with each other, even when it's across invisible lines called borders, still helps us benefit from trading. That's gains from trade again. We're going to go into this in more detail in the next episode, which is about international trade. But remember, the concept is the same. We gain from trade by each focusing on our comparative advantage, which is the job or task we can each do at the lowest opportunity cost. How can we summarise comparative advantage and gains from trade? The Nobel Prize winning economist Paul Samuelson was once teased by a mathematician who was terribly dismissive of economics. The mathematician asked Samuelson to, quote, name one proposition in all of the social sciences which is both true and non-trivial. Samuelson said that comparative advantage was the best example. It's true, as the mathematics can demonstrate. But despite this, he said, there are, quote, thousands of important and intelligent men who've never been able to grasp the doctrine for themselves or to believe it after it was explained to them. Thank God we got women into the workforce so they could understand it. It's just not really that complicated. There are tons of tasks to allocate in the world. And the question is how to do this best. The answer, which is obvious when you think about it, is that you should allocate each task to the person who can do it at the lowest opportunity cost. That means each of us specialising in what we're relatively best at and relying on others for the other stuff. And that's a lot of what markets are all about. They effectively allocate tasks. Each of us picks an occupation in which we have a comparative advantage. And then we use the money we earn to buy the other stuff we need, effectively giving those tasks to others. And the really exciting thing is that this can also explain international trade, which we'll dig into on the next episode. So as our listeners wait, what do you want them to think about this week? As you do various things, from domestic chores like feeding your pets or paying your bills, to professional ones in your workplace, ask yourself, what is the opportunity cost of this task for me? And if it's high, think about whether there's another way to get the task done, perhaps by trading tasks with others or paying someone to do it. That'll free up more of your time to focus on the stuff you're really good at. Your goal is to figure out whether there are ways you can make your life better and enjoy more of those gains from trade. Betsy, Justin, thank you very much. Thanks, Naz. We definitely enjoyed gains from trade with you. I feel really flattered and touched. It's a high compliment from a connoisseur. It's saying that you have a very low opportunity cost. I can't even respond right now because there's no explicit content allowed. To get the most out of this show, check out our bonus episodes and supplemental materials available only on the Himalaya Learning platform. Himalaya Learning provides bite-sized courses from world-class thinkers and industry experts such as Arianna Huffington, Malcolm Gladwell, Tim Ferriss, and more for you to enjoy in the app, on the go. To get the most out of this podcast and others like it, go to himalaya.com slash econ and enter promo code ECON, E-C-O-N, at checkout for your first 14 days free. It's time to think like an economist. Wherever you go, whatever they get into, from chill time to everyday adventures, protect your dog from parasites with Credelio Quattro. For full safety information, side effects, and warnings, visit credelioquattrolabel.com. Consult your vet or call 1-888-545-5973. Ask your vet for Credelio Quattro and visit quattrodog.com.