What is comparative advantage

This is why trade can create value for both parties—because each person can concentrate on the activity for which they have the lower opportunity cost. Portugal could produce both wine and cloth with less labor than it would have taken to produce the same output in England. However, the relative costs are different currencies have different values. Portugal, however, could easily produce both wine and cloth.

Ricardo concluded that while it was cheaper to produce cloth in Portugal than England, it is cheaper still for Portugal to produce excess wine and trade this for English cloth. England would benefit from this trade because its cost of producing cloth has not changed but it can now get wine at a lower price.

Thus, each country can gain by specializing in the good that has a comparative advantage. One of the drawbacks of trade in this way is that it creates increasing interdependence among people or nations.

This is possible as long as it is in the self-interest of each nation and there are no disruptions. In the leading economics textbook, Principles of Microeconomics, Greg Mankiw offers the following:. If her ability to cook is much greater than yours but her ability to clean is only a little better than yours, then you will both be better off if she cooks while you clean.

That is, if you are the less expensive cleaner, you should clean. Even though she has an absolute advantage at everything, you still each have different comparative advantages. Compare their opportunity costs. The magic of comparative advantage is that everyone has a comparative advantage at producing something.

The upshot is quite extraordinary: Everyone stands to gain from trade. Even those who are disadvantaged at every task still have something valuable to offer. Those who have natural or learned absolute advantages can do even better for themselves by focusing on those skills and buying other goods and services from those who produce them at comparatively low cost. When David Ricardo first illustrated the importance of comparative advantage in the early s, he solved a problem that had eluded even Adam Smith.

For example, in the past few years India has become a major supplier of phone-answering services for the American market, even though their English-language skills are not up-to-par. The explanation of the apparent paradox is that the citizens of the importing country must be even better at producing something else, making it worth it for them to pay to have work done by the exporting country.

Amazingly, the citizens of each country are better off specializing in producing only the goods at which they have a comparative advantage, even if one country has an absolute advantage at producing each item. One of the clearest explanations of comparative advantage ever written was in fact one of the first explanations ever written. London: John Murray, First published To produce the wine in Portugal, might require only the labour of 80 men for one year, and to produce the cloth in the same country, might require the labour of 90 men for the same time.

It would therefore be advantageous for her to export wine in exchange for cloth. This exchange might even take place, notwithstanding that the commodity imported by Portugal could be produced there with less labour than in England. Though she could make the cloth with the labour of 90 men, she would import it from a country where it required the labour of men to produce it, because it would be advantageous to her rather to employ her capital in the production of wine, for which she would obtain more cloth from England, than she could produce by diverting a portion of her capital from the cultivation of vines to the manufacture of cloth.

There are many reasons this could be the case, but the most influential is something that economists call rent seeking. Rent seeking occurs when one group organizes and lobbies the government to protect its interests. Say, for example, the producers of American shoes understand and agree with the free-trade argument but they also know that their narrow interests would be negatively impacted by cheaper foreign shoes. Even if laborers would be most productive by switching from making shoes to making computers, nobody in the shoe industry wants to lose their job or see profits decrease in the short run.

Appeals to save American jobs and preserve a time-honored American craft abound, even though, in the long run, American laborers would be made relatively less productive and American consumers relatively poorer by such protectionist tactics. Business Essentials. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page.

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Your Practice. Popular Courses. Part Of. Introduction to Microeconomics. Microeconomics vs. Supply and Demand Basics. Microeconomics Concepts. Economics Microeconomics. What Is Comparative Advantage? Key Takeaways Comparative advantage is an economy's ability to produce a particular good or service at a lower opportunity cost than its trading partners. The theory of comparative advantage introduces opportunity cost as a factor for analysis in choosing between different options for production.

Comparative advantage suggests that countries will engage in trade with one another, exporting the goods that they have a relative advantage in. Absolute advantage refers to the uncontested superiority of a country to produce a particular good better. Compare Accounts. Brazil can produce pounds of beef or 10 autos; in contrast the United States can produce 40 pounds of beef or 30 autos.

Which country has the absolute advantage in beef? Which country has the absolute advantage in producing autos? What is the opportunity cost of producing one pound of beef in Brazil? What is the opportunity cost of producing one pound of beef in the United States? In France it takes one worker to produce one sweater, and one worker to produce one bottle of wine. In Tunisia it takes two workers to produce one sweater, and three workers to produce one bottle of wine. Who has the absolute advantage in production of sweaters?

Who has the absolute advantage in the production of wine? How can you tell? Review Questions What is absolute advantage? What is comparative advantage? Under what conditions does comparative advantage lead to gains from trade?

What factors does Paul Krugman identify that supported the expansion of international trade in the s? Critical Thinking Questions Are differences in geography behind the differences in absolute advantages? Why does the United States not have an absolute advantage in coffee? Look at Self-Check Question 3. Compute the opportunity costs of producing sweaters and wine in both France and Tunisia. Who has the lowest opportunity cost of producing sweaters and who has the lowest opportunity cost of producing wine?

Explain what it means to have a lower opportunity cost. Draw a production possibilities frontier for each country.

Hint : Remember the production possibility frontier is the maximum that all workers can produce at a unit of time which, in this problem, is a week. Identify which country has the absolute advantage in green beans and which country has the absolute advantage in tomatoes.

Identify which country has the comparative advantage. How much would France have to give up in terms of tomatoes to gain from trade? How much would it have to give up in terms of green beans? Glossary absolute advantage when one country can use fewer resources to produce a good compared to another country; when a country is more productive compared to another country gain from trade a country that can consume more than it can produce as a result of specialization and trade.

Anything that leads to different levels of productivity between two economies can be a source of comparative advantage. For example, the education of workers, the knowledge base of engineers and scientists in a country, the part of a split-up value chain where they have their specialized learning, economies of scale, and other factors can all determine comparative advantage. Brazil has the absolute advantage in producing beef and the United States has the absolute advantage in autos.

In answering questions like these, it is often helpful to begin by organizing the information in a table, such as in the following table. Notice that, in this case, the productivity of the countries is expressed in terms of how many workers it takes to produce a unit of a product. Previous: Introduction to International Trade.