🟢 The Misunderstood but Powerful Tool: Comparative Advantage
Why relying on people worse than you can be smart
(2.5 min read)
One of the most counter-intuitive insights in economics is about the difference between comparative advantage and absolute advantage.1
We should care about this lesson because it applies not just at the country or business level but also to each of us in our everyday lives.
Comparative advantage occurs when a person or group can produce a good or service at a lower opportunity cost compared to others.
It’s not about being the best at something; rather, it’s about being more efficient in relative terms.
Examples in text books usually describe international trade, but most of us don’t care about that.
Let’s look at an example relevant to individuals.
Sample scenario to show the math
Imagine two individuals, Alice and Bob.
They are volunteers who raise money by making phone calls or writing letters.
In the scenario below, even though Alice is better at both tasks in absolute terms, they collectively benefit if Alice focuses on calls and Bob focuses on writing letters.
(There are some assumptions, such as the ability to reallocate time and effort between tasks.)
ChatGPT is amazing and helped me build this fancy calculator within minutes!
👇 Click to try it out! 👇
Opportunity Cost Calculation
Alice
Makes 3 calls per hour.
Writes 10 letters per hour (if not making calls).
To make 1 call, Alice sacrifices 10/3 * $10 in letters.
To write 1 letter, Alice sacrifices 3/10 * $50 in calls.
If she splits her time evenly, in 1 hour she makes 1.5 calls and writes 5 letters (total value of $125).
Bob
Is worse at both!
Makes 1 call per hour.
Writes 7 letters per hour.
To make 1 call, Bob sacrifices 7/1 * $10 in letters.
To write 1 letter, Bob sacrifices 1/7 * $50 in calls.
If he splits his time evenly, in 1 hour he makes 0.5 calls and writes 3.5 letters (total value of $60).
Comparative Advantage
By comparing the opportunity costs:
Alice has a lower opportunity cost for making calls ($33.33 vs. $70 for Bob).
Bob has a lower opportunity cost for writing letters ($7.14 vs. $15 for Alice).
Therefore:
Alice should specialize in making calls.
Bob should specialize in writing letters.
Their combined value without specialization was $185, but when they specialize based on their comparative advantage, their combined value per hour is $220.
Isn’t that interesting?
Imagine being Alice, who is better at both tasks than Bob.
Would you be able to happily rely on Bob to handle the task anyway?
Why does this matter for your own life?
Since you’re reading this newsletter, I’m guessing you’re a striver (or a recovering striver).
Someone who holds themselves to high standards.
Maybe you don’t delegate as quickly and often as you should.
You think “I’m better off if I just do it myself.”
Maybe.
But keep the above lesson in mind.
You’ll often benefit by loosening your grip.
I’ve worked places where the executives were better at everything than anyone else. They were better at strategy, better at coding, better at attracting investors, better at recruiting, better at management, and even faster at typing notes.
But they still relied on others’ help.
Assistants to type notes. Engineers to code. Salespeople to make presentations. Cleaners to clean. Etc.
Where can you lower your standards and still get ahead?
You can hire inexperienced interns.
Or teach kids to take responsibility for chores around the house.
Plus, this concept might inspire other helpful behaviors even if they aren’t perfect examples of comparative advantage.
E.g. I once had a therapist who was so bad that he just read questions from a script.
Yet the experience was still valuable to me.
Same with Headspace meditations I’ve been listening to daily.
They’re often terrible.
But it’s not worth my effort to create better ones for myself (even though I could).
What’s easily available is often the best solution.
What do you think?
Where are you able to satisfice?
🕙 What we learned in recent posts:
🟢 The 1 thing you must sacrifice to get what you want
🟢 The cheat code I learned from Steve Jobs and Ray Dalio
🟢 The 2 (contradictory) ingredients to happiness
Thanks for clicking the ❤️ button on this post so more people can discover it on Substack 🙏
For most trained economist - like myself - David Ricardo (who formalised the concept) is a hero.
In the end everything is relative, isn’t it?
Value, perceptions, truth, money, relationships, health.
And even that is fleeting and momentary. What you find valuable right this instant changes in the next instant.
Low value now might be the highest value in a moment.
Deciding on a value comparison is only as good as the instant the person wants to be good at that job. And what they think is interesting changes as fast as you can blink.
It reasons, if you slow that down just a slight bit, the comparison between individuals and what the are good at would likely have differences too.
It’s all in the nuance. Everything is.