we are going to continue discussing gains from trade first we will learn about this really powerful idea called comparative advantage we talked about doordash last time and then one of the things that i think is interesting to think about is that you might be better at driving from a restaurant to your house than the delivery driver you know where your house is probably know where the restaurant is you could probably get from the restaurant to your house without using a map whereas the delivery driver does not know where you live and so they're going to have to use their map and their gps and try to figure out how to get from the restaurant to your house similarly lebron james may be a very good cupcake baker but he buys his cupcakes at a store martha stewart literally has written books about cleaning but we think she pays someone to clean her house example from your book is dwayne the rock johnson does not do his own stunts despite the fact that he is something you'd be very good at he's obviously very strong he has a wrestling history so he has experience doing stunts on camera so why is it these are all examples of why are you paying someone to do a thing that you're probably better at them at so this is uh in order to understand this we need to understand the difference between what we call comparative advantage and absolute advantage so the things we talked about in the last slide is absolute advantage that's the ability to carry out a task more efficiently than other people so martha stewart is probably better at cleaning than the person she pays to clean her house the rock is probably better at movie action stunts than the than his stunt double we want to compare that with what we call comparative advantage comparative advantage is the ability to carry out a task at a lower opportunity cost than other tasks let's think about what we mean well we're going to say that each person should do what they have a comparative advantage in so this is going to explain why lebron chooses to play basketball and buy his cupcakes so lebron's opportunity cost of running a bakery would be the 30 million dollars in nba salary that he forecasts the other hand if lebron's opportunity cost of playing basketball is a million dollar million dollars in bakery profits that'd be a very successful bakery how and that is what lebron is giving up by playing basketball remember your opportunity cost is the cost of what are you giving up what's your next best option if he played plays basketball we'll say his next best option was to run that bakery and earn a million dollars and so what comparative advantage tells us is that lebron should play basketball even though he could run a very successful bakery and what this means is that when we're choosing how to allocate tasks we should not do it based on absolute absolute advantage we should use our comparative advantage to determine what tasks we should do let's look at an example of how comparative advantage can work inside of a home so we have two roommates helen and jamie and they are assigning household tasks so they want to think about who's going to do the vacuuming and who's going to do the cooking and so here we have how long it takes each of them to do each task so to vacuum the house it'll take jamie four hours and helen four hours as well to cook a meal it takes jamie one hour and hell in two hours so the way we're going to figure out the opportunity cost of each task is by thinking about how much of an alternative good can you produce if you don't do this task so what is jamie giving up when he when he vacuums the house he's giving up the opportunity to make a meal and we're going to calculate that by looking at the hours this task takes by the hours required to produce the alternative good let me show you an example i think that'll be more clear than seeing the formula so the raw data is on top so that's what we just saw on the last slide what we're going to do is take that and evaluate the opportunity costs so first we'll think about vacuuming the house it takes jamie four hours the opportunity cost of him vacuuming the house is if he spent that time cooking he could make four meals so if it takes you four hours to vacuum and one hour to cook the time you spend vacuuming those four hours you spend vacuuming you could have cooked four meals and using the formula up top we we find that using four hours is the hour this task takes this task being vacuuming and one hour is hours required to produce the alternative good which is the one hour per meal we get 4 divided by 1 which is equal to 4. he's giving up four four divided by one which is equal to four he is giving up the opportunity to make four meals next let's think about helen it takes helen four hours as well her opportunity cost if she spent that time cooking she would make two meals so it takes helen two hours to make a meal four hours to vacuum so if she were to vacuum the house that means she's giving up two meals she could have cooked two meals in the time it takes her to vacuum the house now let's think about cooking so think about making a meal it takes jamie one hour to make a meal see if i get out of the way here i disappeared takes jamie one hour to make a meal which means his opportunity cost says if he spent that time vacuuming he could clean one quarter of the house he cooks a meal in an hour takes him four hours to vacuum so in the hour he spends cooking he could clean a quarter of the house it takes helen two hours to make a meal and four hours to vacuum so her opportunity cost says if she spent that time vacuuming if she spent those two those two hours vacuuming she could clean half the house so we said that you have a comparative advantage in producing goods for which you have the lower opportunity cost so let's look who has comparative advantage here who is the low-cost producer of vacuuming we want to think about the opportunity cost of vacuuming once well jamie's opportunity cost is four meals and helen's opportunity cost is two meals so who could do it at the lower cost the lower opportunity cost that's helen helen has the comparative advantage at vacuuming because she gives up fewer meals to vacuum who is the low-cost producer of meals well the opportunity cost of one meal for jamie is that he's giving up vacuuming a quarter of the house the opportunity cost for helen is vacuuming half the house jamie only has to give up a quarter of the house whereas helen would have to give up vacuuming half the house jamie has a comparative advantage at cooking so specialization says that you should focus on specific tasks so helen and jamie should not alternate who does the cooking and vacuuming they shouldn't each do half of it if we're actually concerned with being as efficient as possible each of them should specialize so you should spend more time at what you're relatively good at and less time on the other stuff so jamie should spend more time cooking and less time vacuuming which means that we should reallocate tasks according to comparative advantage if helen and jamie each reallocate four hours per week to their comparative advantage let's think about what's going to happen well if helen spends four hours more vacuuming that means the house gets vacuumed one more time if jamie spends four more hours vacuuming if helen spends four more hours vacuuming that means the house gets vacuumed one more time if jamie spends four fewer hours vacuuming that means the house gets vacuumed one fewer times so again this is helen increasing her vacuuming by four hours of jamie decreasing it by four hours now let's think about cooking if helen decreases her time spent cooking by four hours we get two fewer meals when jamie increases his hours cooking by four we get four more meals because they can cook a meal in an hour notice that we have the same amount of vacuuming that takes place right so helen does it one helen gets the house vacuum one more time jamie is back giving the house one fewer time so it's just switched from one of them vacuuming to the other but the house is vacuumed the same amount but let's look at what happens when the meals produced helen's meal production goes down by two but jamie's meal production goes up by four so overall we are we have two more meals produced and this happened again not because we figured out a better way to cook or we could be somewhat jamie got better at cooking all that happened was we reallocated the task of cooking from helen to jamie reallocating tasks creates more stuff and this is an example of gains from trade comparative advantage what if jamie can do everything twice as fast if he as before if he drinks an espresso so he drinks an espresso and he's really amped up and so he can clean faster and he can cook faster let's think about what that's going to look like this is before again it took each of them four hours to vacuum jamie could cook a meal in an hour helen takes two hours after an espresso what used to take him four hours he can do in two hours what used to take him one hour you can do it a half hour let's think about what that does to opportunity costs well here are the opportunity costs from before we already calculated these helen's opportunity costs stay the same because nothing changed about how efficient she is let's think about what happens to james so what is jamie's opportunity cost of vacuuming after he has that espresso well it takes him now it takes him two hours to vacuum and a half hour to cook a meal which means every time he vacuums for two hours he cleans he cleans the house once but gives up four meals to do so so his opportunity cost of vacuuming is four meals now what if he cooks a meal what is his opportunity cost of cooking a meal takes him half hour to cook a meal and two hours to vacuum so if he spends a half hour cooking a meal that means he misses out he gives up vacuuming one quarter of his house and neat takeaway here his opportunity costs are unchanged because he became more efficient at producing both goods and opportunity cost is all about your relative costs and so if both costs increase by the same amount both he becomes twice as efficient your opportunity costs are unchanged which means that opportunity costs were unchanged so the task division is unchanged it should still be the case that jamie is cooking dinner and helen is still vacuum why because if we go back it is still the case that helen has the comparative advantage at vacuuming she can her cost is two meals his is four and jamie still has a comparative advantage at cooking so this still happens even though jamie is now better at both tasks so everyone has a comparative advantage even if you lack absolute advantage in anything you are least bad at something right so even though helen is worse than jamie at all tasks once he has that espresso she still has a comparative advantage at vacuuming so where do the gains of trade come from let's sort of think about what we've learned so far and try to put it together and think about all right we know that there are gains from trade how do we get them they come out prevalently from allocating tasks rearranging who does what so we shift tasks from the person with the high opportunity cost to the person with the low opportunity cost so here we switched cooking responsibilities from helen to jamie and sh that ensures that each task minimizes the resources used so we're minimizing the amount of time spent doing dinner cooking by making jamie do the one who does it this example comes from the book and at the end of the example they real they reveal that jamie is a stand-in for jamie oliver who's a chef and the reason i mention that is because another way that we get gains from trade is that markets help people discover and exploit gains from trade so markets work to help us find what our comparative advantage is so you specialize in one task and buy from other people for the rest of this of the tasks that allows them to specialize in their preferred task so what that means is jamie finds out that oh turns out that i can cook really fast and i know this because i think about selling the food i've cooked and i'm able to sell a lot of food that i cook because i cooked it really fast and oh it makes it seem like i have a comparative advantage there because i can make a lot more money cooking than i can vacuuming and so he decides that he's going to specialize in cooking and pay someone else to do his vacuuming or trade trade cooking services for vacuuming services i guess what's going on in his uh apartment situation specialization drives trade we are trading trading tasks with others can make you both better off so if you think about when you are your trade that you make every day so if you go to the store and buy that reese's cup because you couldn't get it trick-or-treating well what happened was you traded whatever it is that you do for to make money so you know maybe it's a campus job you traded a few minutes of that work you did at your campus job for a reese's cup because hershey is better at making reese's cups they have you know huge assembly lines that they can crank out lots of reese's cups faster than you can and you have a comparative advantage at whatever your job is so comparative advantage is all about task allocation which means that we can see the ideas of comparative advantage anytime we see tasks so here's some example we have allocations of tasks within a household so we talked before about sort of allocating household chores but for the perspective of a family we could think about who's has the task of going out working in the market and getting paid who looks after the kids you can think of allocation of tasks in a workplace place who crunches the numbers who works with clients we talked about the receptionist who has the responsibility of the receptionist tasks and the ceo who has responsibility for growing the business allocation of tasks between firms so if you have a firm you're going to specialize in something maybe you have a bunch of people who are really good at making computers maybe you have a lot of coders who are good at making software allocation of tasks between government and market so for example if the government sort of thinks about all right what do i want what can i do well what is something better left to the market so who funds prisons who runs prisons allocation of tasks across countries so who invents the iphone who manufactures it and we'll talk more about international trade in the next lesson so we can think about the way this works as is at currently is that apple has a lot of highly educated designers and engineers in the united states so they invent the invent the iphone in the united states china has a comparative advantage in manufacturing so the iphone is manufactured in china we're going to look at a real world application and think about how task allocation applies to families so think about a 1950s style marriage that was all about specialization and a very specific type of specialization usually dad worked out in the market mom worked in the home took care of the kids kept the house clean since then there's been a lot of changes in the benefits and opportunity costs for being a full-time stay-at-home mom so specifically think about the opportunity cost of being a full-time home maker is that you're giving up the chance to work outside the home these opportunity costs have increased because the benefits of working outside the home increased why is that well since that we think about there's been much a great increase in female education many more women with college degrees and advanced degrees there's also been anti-discrimination laws that have hopefully made the workplace less hostile to women another thing that's happened is there's been household automation and trade had increased of house trade of household tasks what that means is the benefits of staying at home decreased because many tasks that were traditionally performed by mothers can now be automated so dishwashing now can be automated by a dishwasher or outsourced so like things like meal kits or getting take out food so it used to be that the benefits of being a mom was that was basically the best chance your family had of having a clean house and having meals is that you would have someone in your house who would do those tasks now it's much easier to outsource those and not and not have to spend as much time doing them as a result we think about what's just happened the opportunity costs of being a home time home full-time homemaker have risen the benefits of do of being a full-time homemaker have fallen and so because comparative advantage is all about the opportunity cost of what you give up it is now less common for men to have a major comparative advantage at working outside the home and so you'll see more scenarios where both parents work for a scenario where mom works and dad stays home with the kids and so we have many more married women in the workforce than we used to next we are going to discuss the role of prices all of this economic activity that we've talked about is coordinated by prices so whether it's you selling your grandma's gift on ebay or lebron deciding to buy his cupcakes or mom and d or dad deciding which job to get or you deciding whether or not you should get doordash all of that is coordinated by prices so brings us to questions like should you pay for door dash delivery should you buy pre-cut vegetables is it worth the price for the time you save should you get a job cutting vegetables so maybe you're cutting slicing vegetables you realize you're very good at it and you decide to get a job at the grocery store pre-cutting vegetables all of this is going to be determined by prices so is it worth the extra price to buy pre-cut vegetables do they do you make enough money if you get a job cutting vegetables markets are organized through prices prices inform buyers of where each resource is most valuable this allows resources to be allocated to their best use now we're going to think about what this means and i want us to think about three things that prices are prices are a signal prices are an incentive and also prices aggregate information so let's look at each of these three roles first roll price is a signal prices signal to potential suppliers how much buyers value their products in doing so prices reveal the buyers marginal benefit a high price is a signal from buyers hey we really benefit from this stuff please make more of it prices signal to potential buyers about the opportunity cost of providing a good which means that prices reveal the seller's marginal cost a high price is a signal from producers hey this stuff is expensive to produce please use it carefully so these right here are truffles truffles are one of the most expensive foods you can buy they are kind of mushroom they're difficult to find they um they're difficult to keep fresh and so when you go to a restaurant because the price of mushrooms is high what that is a signal for if someone's running a restaurant that they are going to not you typically not use a lot of truffles in their food if you get something with truffles there's typically truffle shavings on top sometimes you can get fancy french fries that have truffle oil and all of these are ways to try to maximize the truffle flavor while using less of these of this very expensive ingredient and so in general we say prices coordinate better outcomes they help to facilitate the activities of people around the globe so think about truffles i think a lot of truffles come from france and without prices we might have something going on where these people are making truffles in france they're like hey these are really hard to come by please try not to use them in huge quantities than the um someone in the united states is saying hey people really like truffles grow some more of them and so instead prices work to facilitate these this sort of communication and ensure that supply equals demand here's one example so this is the price of peruvian quinoa quinoa is a grain that has become very comp very popular in the united states there's been a huge increase in western demand for quinoa and that has skyrocketed the price of quinoa and how does that serve as a signal well it's a signal to farmers in the andes hey make more of this it's the signals to signal the quinoa buyers cut back switch to another grain so we're going to continue thinking about this example of quinoa and move on to the second roll a price is an incentive so the reason people respond to price signals is because of incentives right so the reason that the restaurant responds but to the signal of hey truffles are expensive by using fewer truffles in their food is because they have an incentive to try to save money on their ingredients and so a high price is an incentive for suppliers to produce more so specifically one of the things that happened because of the high price of quinoa farmers in the andes switch from raising llamas to growing quinoa because of an increase in profit opportunities so oh quinoa sells for a lot of money i could make more money growing quinoa that i can't raising llamas therefore i am going to choose to grow quinoa it leads to buyers consuming less so the opportunity cost of consuming quinoa rises so which is an incentive for people to consume less quinoa so i go to the store i see the prices and i say oh if i buy a pound of quinoa that means i'm giving up three pounds of rice so i'm going to say oh because of this i'm going to buy less quinoa and switch over to more rice a high price is also an incentive for strangers to cooperate and what i think about it is your local restaurant this is a quinoa dish and the peruvian farmer have an incentive to work together both of them know that they're going to make more money if they can get a quinoa dish to you and you're willing to pay for it because you like quinoa the third roll is that a price aggregates information and by aggregating information that enables people to make better decisions so let's think about gold and platinum so the prices of gold and plot the prices of gold and platinum are set by a variety of factors including their rarity and how each one can be used so that price of gold the price of platinum will aggregate a lot of information about the costs of producing each the benefits of each various uses for each and it happens that platinum is more expensive than gold this means of all the uses and all the things knowing about how difficult it is to make each platinum is more expensive which means it's more valuable people get more use out of it it's more difficult to produce so that is that serves as an incentive for people making wedding rings if you're making a wedding ring you're saying hey dude the price the way the prices are says you should probably be making most of your wedding rings out of gold well that frees up more platinum to be used for things that gold can't be used for so one of the most common uses for platinum is that it's used in catalytic converters in cars something about platinum's chemical properties make it good at cleaning the pollutants out of your car's exhaust and again prices aggregated the information of hey there's things that you can use platinum for but not gold and that as a result we get gold used for wedding bands platinum used for catalytic converters another place you see prices aggregating information are the is the stock market so prices in the stock market can tell you a lot so maybe there's technology experts who are optimistic about apple's future and i think they have some really good products coming out that they're going to sell a lot of those people would be led to buy then there might be experts who are pessimistic and they might sell so they think that apple's new products are not going to sell as much or that they're going to have a hard time producing them that would lead them to sell apple stock apple's stock price then is going to come to reflect this aggregated wisdom the aggregated beliefs of people who are optimistic and people who are pessimistic and that's going to lead to an apple share price one powerful example on the power of market forces is the korean peninsula so japanese troops surrendered in korea at the end of world war ii soviet union accepted the surrender in the north they implemented central planning the united states accepted the surrender in the south implemented a market economy and there has been been two vastly different outcomes since then both koreas were equally poor at the end of the war however today the annual income uh differs drastically so in south korea it's about 36 000 per year north korea it's about 1800 per year this picture behind me is a picture of north and south korea taken at night you'll see the brightness of the all the lights in south korea reflects all the industry and business that's going on last thing i'm going to show you is the idea of market forces and how they relate to a pencil so this is a really famous video it's milton friedman talking about the about a pencil and there's links here there's a short version which is just a couple minutes and then there's a long version which is still only 10 minutes long they're really really cool to watch so here's some of the quotes from it he said there's not a single person in the world who can make this pencil why because there's wood from washington state graphite from south america rubber from malaysia literally thousands of people cooperated to make this pencil when you go down into the store and buy this pencil you're in effect trading a few minutes of your time for a few seconds of the time of all those thousands of people the person who cut down the tree and the person who harvested the rubber and the person who knew how to turn that metal in into the end of the eraser and so on most of these people don't know each other and their work was their work was not coordinated by some central office in charge of pencil production last quote from him is it was the magic of the price system that brought them together and got them to cooperate to make this pencil