How to Calculate Comparative Advantage (Opportunity Cost)
Find comparative advantage by comparing opportunity costs — the producer with the lower opportunity cost for a good has the comparative advantage in it.
Formula
Opportunity cost of 1 unit of Good A = (units of Good B given up) ÷ (units of Good A gained). Lower ratio = comparative advantage.
Steps
- 1Set up the output table. List how much of each good each producer can make with the same resources.
- 2Compute opportunity costs. For each producer, the OC of one good = the other good's output ÷ this good's output.
- 3Compare and assign. The producer with the lower opportunity cost for a good has the comparative advantage in it and should specialize there.
Worked example
US: 100 wheat or 50 cloth → OC of 1 cloth = 100/50 = 2 wheat. Mexico: 40 wheat or 40 cloth → OC of 1 cloth = 40/40 = 1 wheat. Mexico's OC is lower, so Mexico has the comparative advantage in cloth.
Frequently asked questions
How is comparative advantage different from absolute advantage?
Absolute advantage is making more with the same resources; comparative advantage is making something at a lower opportunity cost. Trade is based on comparative advantage.
What is the 'output' vs 'input' method?
With output problems (units produced), divide the OTHER good by the good in question. With input problems (resources per unit), divide the good in question by the other — the rule flips.