In economics, the law of comparative advantage is the ability of one party to produce a particular good or commodity at a lower marginal cost than another.
Thus even if one country produces goods at a lower cost than another, through trading with each other both countries will be better off in the long run, provided that their relative efficiencies are different.
Ricardo used the 19th century example of Britain and Portugal: Britain should focus on producing cloth and Portugal on producing wine.
Provided that trade costs are not too high and tariffs do not distort the market, Britain and Portugal through trading with each other should be better off.
Today, Australia’s advantage is our mineral wealth. Other industries are struggling with high wages costs, yet the mining sector continues to ramp up our exports to China (while China instead focusses on its industrial production and construction boom).
Should Tiger Woods mow his own lawn?
Closely related to the idea of comparative advantage is that of absolute advantage.
Tiger Woods over the years has had an absolute advantage at playing golf – he’s been able to do it better than anyone else.
Now here’s a question: should Tiger Woods mow his own lawn?
Clearly, he could save some money by doing so, perhaps the $50 or so that he would have to pay someone to cut his grass (no pun intended).
But the key consideration in this case is really opportunity cost and the value of the time that Tiger would be giving up.[sam id=31 codes=’true’]
Given his almighty earning potential a a golfer and ambassador for major brands, he’d probably be better off spending an hour on the driving range.
We actually make these types of decisions unconsciously almost all the time, and not only related to financial decisions.
My missus is a better cook than me, for example, and therefore it makes sense that she does the cooking every night.
Ha…and you think I’m joking.
Other areas of advantage that she holds include, cleaning, ironing…
On the flip side, I was employed as a kitchen porter and barman as a teenager, so, unfortunately for me, I hold the ‘advantage’ in washing the dishes and cutlery after the meal. Such is life.
I often say that one of the absolute key elements to financial success is to spend less than you earn and invest the difference. In fact, this is vital to succeeding financially.
However, as you get older, it’s generally the case that people earn more as they gain experience and expertise in their field. Your time tends to become worth more.
I think I’ve mentioned before that I would never have paid for a car-wash when I was 18 years old.
No way in the world!
Why spend a few dollars (or pounds) of very hard-earned cash for a task I could undertake myself at the weekend? Especially as my car was my pride and joy at that time.
As you get older, however, the decisions become a little more complicated.
This sprang to mind today when I handed over $75 to my hairdresser for a cut (yes, yes, I know…it looks better now, OK?) and I cast my mind back to the £3 I spent on ‘crew cuts’ as a teenager.
The thing is, I now see using an expert hairdresser as a worthwhile expense – again, I must stress, it looks much better now…
Not dissimilarly, next week I’m doing some filming work, and I think I’ll buy a new shirt over the weekend for the occasion. I have plenty of shirts already, of course, but if I’m filming I want to present myself as well as I possibly can.
I see it as worth the expense.
Not a contradiction?
This might sound a little contradictory given that I regularly insist that spending less than you earn is a pre-requisite for financial success.
However, as also noted, as one gets older and your earning capacity from your investments, your business and employment grows and compounds, sometimes it pays to spend more money on paying an expert or on paying for quality, allowing you to focus on what you do well.
I use one of the world’s largest accounting firms as my accountants and advisors, to lodge my company accounts, and to ensure that my self-managed superannuation fund (SMSF) accounts are lodged and are fully compliant.
Of course, I could pay a cheaper accountant, but at what real cost?
When I have a difficult technical issue or I need tax or legal advice, I know that the world’s largest accounting firms have the resources and experience to solve problems for me. For mine, that’s worth paying for.
Often-times, to make money you have to spend money.