Question

Question: In terms of comparative advantage, explain how does the Iowa Car Crop works.

(IOWA CAR CROP STORY)

There are two technologies for producing automobiles in America. One is to manufacture them in Detroit, and the other is to grow them in Iowa. Everybody knows about the first technology; let me tell you about the second. First you plant seeds, which are the raw material from which automobiles are constructed. You wait a few months until wheat appears. Then you harvest the wheat, load it onto ships, and sail the ships eastward into the Pacific Ocean. After a few months, the ships reappear with Toyotas on them.

International trade is nothing but a form of technology. The fact that there is a place called Japan, with people and factories, is quite irrelevant to Americans’ well-being. To analyze trade policies, we might as well assume that Japan is a giant machine with mysterious inner workings that convert wheat into cars. Any policy designed to favor the first American technology over the second is a policy designed to favor American auto producers in Detroit over American auto producers in Iowa. A tax or a ban on “imported” automobiles is a tax or a ban on Iowa-grown automobiles. If you protect Detroit carmakers from competition, then you must damage Iowa farmers, because Iowa farmers are the competition.

The task of producing a given fleet of cars can be allocated between Detroit and Iowa in a variety of ways. A competitive price system selects that allocation that minimizes the total production cost. It would be unnecessarily expensive to manufacture all cars in Detroit, unnecessarily expensive to grow all cars in Iowa, and unnecessarily expensive to use the two production processes in anything other than the natural ratio that emerges as a result of competition.

That means that protection for Detroit does more than just transfer income from farmers to autoworkers. It also raises the total cost of providing Americans with a given number of automobiles. The efficiency loss comes with no offsetting gain; it impoverishes the nation as a whole.

There is much talk about improving the efficiency of American car manufacturing. When you have two ways to make a car, the road to efficiency is to use both in optimal proportions. The last thing you should want to do is to artificially hobble one of your production technologies. It is sheer superstition to think that an Iowa-grown Camry is any less “American” than a Detroit-built Taurus. Policies rooted in superstition do not frequently bear efficient fruit.

In 1817, David Ricardo—the first economist to think with the precision, though not the language, of pure mathematics—laid the foundation for all future thought about international trade. In the intervening 150 years his theory has been much elaborated but its foundations remain as firmly established as anything in economics.

Trade theory predicts first that if you protect American producers in one industry from foreign competition, then you must damage American producers in other industries. It predicts second that if you protect American producers in one industry from foreign competition, there must be a net loss in economic efficiency.

Answer 1

Comaparative Advantage is the ability of a firm or an individual to produce goods and/or services at a lower opportunity cost as compared to other firms or individuals and to generate greater sales margin. Sometimes, we confuse it with being the best at something and coining a term called specialisation. In case of Iowa car crop theory, Detroit is best when it comes to manufacturing and on the other hand Iowa is best at growing or producing. Though they specialise in their respective area, it does not mean that economically, they are efficient. Going by the concept of Comparative Advantage Theory, instead of killing the compeition, both Iowa producers and Detroit maufacturers can trade among each other in the optimal proportion which in a way would benefit both the parties i.e. total production cost for Iowa and Manufacturing cost for Detroit would be greatly minimised because adopting the method of Specialisation would be unnecessarily expensive for both of them. Procuring wheat from producers to convert into car by the help of techology may prove to be cheaper for Detroit in any circumstance. Similarly,  procuring direct manufactured cars from Deroit by Iowa would greatly pull down the cost of production of Iowa also. This would also benefit the population by providing better produced cars in low prices and better usage of saved funds resulting from the production cost cutting due to comparative advantage.