During the height of the Democratic primary season in 2016, Senator Bernie Sanders made news by lamenting “You don’t necessarily need the choice of 23 underarm spray deodorants or 18 different pairs of sneakers when children are hungry in this county.” Bernie asks an interesting economic question – why do we have so many choices between products that are essentially the same thing? Paul Krugman won the Nobel Prize in 2008 in part for answering this question.
Traditional trade theory supposes that each party (person, city, state, country, etc.) will spend their time doing what is less costly for them to do compared to their trading partner. Economist David Ricardo developed this theory, called comparative advantage, in 1817. This is why Florida produces a lot of oranges and Iowa a lot of corn. The two parties specialize and trade with one another, making both better off.
But what if a country or firm’s “comparative advantage” isn’t so obvious to the casual observer? For example, why does the United States produce Fords, Chevys and Jeeps, but still trades for Toyotas, BMWs, and Volvos? Shouldn’t someone – whether it’s the United States, Japan, Germany or Sweden – have the comparative advantage in car manufacturing?
Krugman expanded our understanding of international trade by addressing these realities. It turns out that consumers love to have choices. Krugman argued that the globalized market expands the opportunities for firms to experience savings in costs as they produce more goods. Economists term this relationship between production and costs economies of scale.
As our wealth rises and we spend a lower percentage of our income on necessities, we demand greater variation in the goods we consume. Economies of scale produce greater diversity in products at lower prices for consumers. Krugman’s analysis helps explain that while a Toyota Corolla and Jeep Wrangler serve the same purpose, there are thousands of fine differences between the two that our increased wealth allows us to care about. We wouldn’t enjoy the multitudes of product differences if it weren’t for the dramatic increase in wealth brought about by specialization and globalization.
In somewhat of a strange connection, Krugman’s work exposes the economic ignorance behind Bernie Sanders’ tantrum about deodorant and sneakers. We have 23 choices in deodorant because of our incredible wealth, not despite it. It turns out Bernie doesn’t spend much time studying Nobel winning economists! Please contain your expression of shock.
Moving to the Big City
The second part of Krugman’s analysis helps explain why so many of us are drawn to big city living despite the traffic congestion, high cost of living and RATS. Krugman argued that highly populated areas are better able to take advantage of the economies of scale described above. City dwellers get to enjoy great diversification of goods at lower prices. Krugman argued that the benefits of a highly populated area are self-reinforcing. The greater supply of diversified goods and lower prices induce greater migration to the area, and so on.
So what’s stopping every person and firm from moving to the big city? Krugman notes that “transport costs” provide a tradeoff to the possible economies of scale. It’s expensive and difficult for firms to move around. For families, moving means leaving behind standards of living that may not show up in a data set, such as relatives nearby.
Krugman helps explain why it’s common for high amounts of University of Notre Dame grads to move to nearby Chicago after graduation. The big city will tend to offer greater pay and more choices in entertainment, food, and housing. Chicago’s close location tends to maximize the benefits of big city living and minimizes transport costs for many Notre Dame grads.
As time progresses and transport costs fall– air travel, for example – should we expect greater competition between cities for firms and workers? Or could we see greater consolidation of one or two dominant cities? Why are we moving so infrequently now? What may be the impact on the “self-reinforcing growth” of urban living with so many recent college graduates living with their parents?
There are many interesting questions surrounding the future of free trade, product diversification and urban living. Krugman’s past work will continue to provide insights into these complex areas.