Tuesday, February 23, 2010

Law of Comparative Advantage

The Law of Comparative Advantage
Long name that basically says that even if you have the ability to do something, it's to your advantage to let someone else do it if you can be more efficient at something else.

This is nothing new, but it helped me understand why, in a truly free economy, you wouldn't have megalithic corporations that do end-to-end vertical production as well as having a huge breadth of products. In our current setup, government tax schemes have created an environment where it is to the advantage of the corporation to provide everything "in-house". This means that because of taxes that Dell would pay to buy network cards from some manufacturer, it would be cheaper for Dell to manufacture their own network cards for themselves. Soon it becomes nearly impossible for an upstart to get into the market because in order to be able to compete at Dell's prices, you have to start with a massive manufacturing infrastructure to avoid the same tax penalties. 

Even in situations where one person/group is better at everything they do than anyone else, it's still going to be to their benefit to cooperate:

You want increased competition and smaller megalithic corporations? Lower the barriers of entry into the market (i.e. regulations, taxes, permits, etc) and don't incentivize monolithic practices while claiming to despise them. Through a combination of comparative advantage and increased competition, you'll see that companies find it beneficial and more profitable to do one thing, and do it very well. In the end, it's the customers, we consumers that benefit.

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