What is a Comparative Advantage?

//What is a Comparative Advantage?
What is a Comparative Advantage? 2017-10-01T07:55:27+00:00

Definition: Comparative advantage is defined as the skill of producing a particular good or service more cost-effectively than other producers. In other words, it’s when company can produce a better quality product cheaper than its competitors. The law of comparative advantage applies to International Trade and was introduced by David Ricardo in the early 1800s.

What Does Comparative Advantage Mean?

What is the definition of comparative advantages? Foreign trade seeks to improve a country’s income position. This is possible if each country focuses on the production of certain goods based on the principle of comparative advantage cost. A country has an advantage over another if the opportunity cost of production of a particular good is lower in that country than it is in others. In this context, countries can equally benefit from trading specialized goods.

On the other hand, the theory of comparative advantage fails to answer why production costs are different between countries and it does not take into consideration the possibility of producing the same goods with a different combination of production factors.

Let’s look at an example.

Example

Country A produces cranberries and country B produces oil. The two products are consumed domestically without any trade-taking place between the two countries. The cost conditions for profit maximization are the following:

Country A focuses on the production of cranberries because it is cost-effective for A to efficiently use the factors of production of cranberries and import oil from country B. In this case, the advantage of country A is that the unit cost of cranberries is half the unit cost of cranberries in country B, while the unit cost of oil in country A is twice the unit cost of oil in country B.

In the same way, the advantage of B is that the price of oil is half the price of oil in A, while the price of cranberries is twice the price of cranberries in A. Therefore, B focuses on the production of oil.

This doesn’t mean that either country is overall better at producing oil or cranberries. It just means that they have to sacrifice less to produce them.

Summary Definition

Define Comparative Advantages: Comparative advantage means one company can produce a good or service more efficiently than a competitor because of its unique operations or level of resources.