Wednesday, May 09, 2007

Ricardo's Law

While reading Snakes on a Plane (I'm a big fan of Buffy, and of Buffy crossovers) I got to this part:

Did they even have stores selling clothes and groceries and stuff back then, or did everybody make their own clothes and grow their own food? That seemed like a lot of wasted effort to Buffy. If you were good at making clothes or something, shouldn't that be, like, your job? And then you could sell the clothes you made or trade them to somebody who was good at growing things.

This is something that most people seem to understand intuitively. If you're better at making bread, and I'm better at making clothes, we should specialize and trade with each other, instead of each of us trying to make both. We'll have products of a better quality (or a greater quantity, depending on the meaning of "better" in the previous statement). This is why, for example, it makes sense to grow corn in Kansas and bananas in Kenya and trade, instead of each trying to do both.

What some people don't realize, because it is counter-intuitive, is that you don't even need an absolute advantage for trade to be beneficial. Consider the case of a good lawyer (ok, efficient lawyer [grin]) with a bad assistant:

  • the lawyer can get $200 an hour for legal advice

  • he can also type and file well enough to generate an income of $50 an hour

  • his assistant would only be able to get $10 an hour for legal advice

  • not being as good an assistant, he would also only do work worth $20 an hour

Even in this case, with the lawyer having a devastating advantage in both legal and secretarial work, it still pays off for him to only handle the legal advice and to hire the assistant for the rest. That's because of an important, but overlooked thing: during the time he's doing a good job typing or filing or whatever, he's not doing a great job getting paid for legal advice. In other words, for every hour spent doing the work of an assistant, he loses $150. Given that fact, it is better if he hires the assistant for $20 - he saves $130 for each hour he would have otherwise spent doing a less financially rewarding job.

More information can be found in the Wikipedia article... while I'm not a big fan of Wikipedia (way too many socialists in the world), this is actually a well-written article.

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