What is comparative advantage in Economics ?

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An economy is said to have a comparative advantage if it produces goods or services at an opportunity cost lower than that of its trade partners. This means that the particular economy will have products at a lower price than that of their competitors and will be able to realize more significant profit margins. The theory of comparative advantage is attributed to David Ricardo, who wrote a book on political economy and taxation calculation in 1817.

Comparative Advantage Broken Down

Comparative Advantage is one of the most fundamental theories in economics. The theory proposes that all actors in a trade can, at all times, benefit from cooperation. In addition to getting help calculating comparative advantage, to understand comparative advantage fully, you need to understand opportunity cost, which means the benefits, lost when one option is chosen over another. In the case of comparative advantage, it says that one economy has a lower opportunity cost than its competitors. The one with a low opportunity cost has the lowest potential benefit lost and, therefore, has a comparative advantage.

Another simple way of looking at a comparative advantage is considering the best option chosen given a trade-off. If, for example, you have to choose between two deals, each with advantages and disadvantages, and analyzing each case's graph, the one that offers the most benefits with few to no drawbacks is the one that holds a comparative advantage.

Comparative Advantage and Absolute Advantage

While comparative advantage is concerned with producing goods at a lower opportunity cost, absolute advantage is concerned with the ability to deliver more and high-quality goods or services than competitors.

For instance, consider a teacher and her secretary. A teacher is good at delivering teaching services and earns $100 per hour teaching, and is also good at secretarial work and can earn up to $30 an hour typing and organizing. In such a case, the teacher has an absolute advantage in both teaching and secretarial work. However, both the teacher and her secretary can benefit from cooperation.

The secretary earns $0 in teaching services while the teacher earns $100. Where the teacher earns $30 in secretarial work, the secretary earns $25. In this case, you have to consider the opportunity cost. For the teacher to earn $30 from secretarial work, the teacher will have to forfeit the $100 she would earn from teaching. The opportunity cost of the teacher doing secretarial work is high, and she's better off teaching. The secretary is better placed to do secretarial work as her opportunity cost is so low.

Comparative Advantage and Competitive Advantage

Competitive advantage refers to the ability of an economy to offer better value to consumers compared to competitors. This is almost the same as a comparative advantage but with only a little difference. For a company to have a competitive advantage, it needs to offer goods at lower prices, provide superior goods and services, and focus on a given segment of the consumer pool.

Comparative Advantage and International Trade

Comparative advantage has helped countries make more money by specializing their trade to match their comparative advantages. As David Ricardo shows, England was able to cheaply manufacture cloths and Portugal able to brew wine at lower prices. Ricardo predicted that as soon as these countries realized the comparative advantage one product has over the other, they concentrated their production on the product that held a comparative advantage. Eventually, England focused on wine production and concentrated on clothes and Portugal concentrated more on wine and stopped manufacturing clothes.

Another good example is China and the USA. China can produce simple consumer goods such as cutlery and very low opportunity cost while the US can produce specialized and capital-intensive labor at low cost. The US can produce sophisticated goods at low opportunity costs. By sticking to these lines, both countries can benefit from their trade.

With comparative advantage, economies can realize their problems, outshine their competitors, and choose trade partners effectively. Economies that have been trading internationally have already worked towards finding trade partners who hold a comparative advantage on one or more goods and services.

If a country cuts all international links and walks away from international trade, they may have a few advantages by creating local opportunities. However, such a state will suffer in the long run as it does not benefit from trading with companies that can produce goods at a lower opportunity cost.

Comparative Advantage for Individuals

Comparative advantage can help individuals make career decisions. If, for instance, a skilled footballer earns more money coaching than playing, he and everyone he coaches are better off as a coach. With more general levels of opportunity, the cost has a higher production values.

When people have diverse skills, there is a more significant opportunity through trade. An athlete such as Cristiano Ronaldo can paint his house faster than any other painter he might hire. However, in the few hours, he would spend painting his house; he can take part in a TV commercial and earn more than $50,000.

What is comparative advantage in Economics