Comparative Advantage
What is Comparative Advantage?
Comparative advantage is the ability to produce a good at a lower opportunity cost than another producer.
Even if one producer has an absolute advantage in everything, both gain by specializing in the good they sacrifice the least to make and then trading. The producer with the lower opportunity cost for a good should specialize in it. Mutually beneficial trade happens when the terms of trade lie between the two producers' opportunity costs.
Comparative Advantage: a worked example
Farm A can produce 60 bushels of wheat or 30 bushels of corn in a season; Farm B can produce 20 bushels of either. Farm A gives up 0.5 corn per bushel of wheat (30 ÷ 60) while Farm B gives up 1 corn per bushel of wheat (20 ÷ 20), so Farm A has the comparative advantage in wheat, and Farm B, whose corn costs only 1 wheat against Farm A's 2 wheat (60 ÷ 30), has it in corn. At terms of trade of 0.75 corn per bushel of wheat, Farm A receives 0.75 corn for wheat that cost it 0.5 corn to grow and Farm B pays 0.75 corn for wheat that would have cost it 1 corn to grow, so both gain 0.25 corn per bushel traded even though Farm A is better at producing both goods.
The mistake students make with comparative advantage
Students pick whichever producer makes more of a good and call that a comparative advantage, but producing more is absolute advantage. Comparative advantage is decided only by what is sacrificed: in an output table, the opportunity cost of one unit of a good equals the other good's output divided by that good's own output, and the producer with the smaller number has the comparative advantage. That is why a producer who is worse at making everything still has a comparative advantage in something.
Comparative Advantage questions
Can one producer have a comparative advantage in both goods?
A single producer cannot hold the comparative advantage in both goods, because a lower opportunity cost in one good mathematically forces a higher opportunity cost in the other. The one edge case is two producers with identical opportunity costs, where neither has a comparative advantage in either good and trade produces no gains.
What is the difference between comparative advantage and absolute advantage?
Absolute advantage means producing more of a good with the same resources, while comparative advantage means producing it at a lower opportunity cost, and it is comparative advantage that determines who should specialize and trade. A country can hold an absolute advantage in every good and still gain by trading according to comparative advantage.
How do you calculate comparative advantage from an output table?
For each producer, divide the output of the other good by the output of the good in question to get that good's opportunity cost, and the producer with the lower result has the comparative advantage in it. A producer making 60 wheat or 30 corn, for instance, gives up 30 ÷ 60 = 0.5 corn for each bushel of wheat.
Formula / Example
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Related terms
Common comparisons
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