Comparative Advantage

In economics, the law of comparative advantage refers to the ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another. Even if one country is more efficient in the production of all goods (absolute advantage in all goods) than the other, both countries will still gain by trading with each other, as long as they have different relative efficiencies.

For example, if, using machinery, a worker in one country can produce both shoes and shirts at 6 per hour, and a worker in a country with less machinery can produce either 2 shoes or 4 shirts in an hour, each country can gain from trade because their internal trade-offs between shoes and shirts are different. The less-efficient country has a comparative advantage in shirts, so it finds it more efficient to produce shirts and trade them to the more-efficient country for shoes. Without trade, its opportunity cost per shoe was 2 shirts; by trading, its cost per shoe can reduce to as low as 1 shirt depending on how much trade occurs (since the more-efficient country has a 1:1 trade-off). The more-efficient country has a comparative advantage in shoes, so it can gain in efficiency by moving some workers from shirt-production to shoe-production and trading some shoes for shirts. Without trade, its cost to make a shirt was 1 shoe; by trading, its cost per shirt can go as low as 1/2 shoe depending on how much trade occurs.

Another example: Say you have John who makes $300 an hour and he hires a maid who works for $25 an hour. It takes John 1 hour to clean his house compared to his maid who takes 8 hours to clean his house. John has an absolute advantage over his maid but the maid has a comparative advantage. This is because if John cleans his house by himself, he loses $300. If he hires the maid, he makes a profit of $100.

The net benefits to each country are called the gains from trade.

Read more about Comparative AdvantageOrigins of The Theory, Modern Theories, Effect of Trade Costs, Effects On The Economy

Other articles related to "comparative advantage, advantage, comparative":

Modern Economics - Microeconomics - Specialization
... According to theory, this may give a comparative advantage in production of goods that make more intensive use of the relatively more abundant, thus ... Even if one region has an absolute advantage as to the ratio of its outputs to inputs in every type of output, it may still specialize in the output in which it has a ... outputs and productive inputs select an allocation of factor inputs by comparative advantage, so that (relatively) low-cost inputs go to producing low-cost outputs ...
Free Trade Debate - Criticisms of Free Trade - Economic Arguments Against Free Trade - Capital Mobility and Comparative Advantage
... Some descriptions of comparative advantage rest on a necessary condition of capital immobility ... If financial or labor resources can move between countries, then comparative advantage erodes, and absolute advantage dominates ... For instance, the Heckscher-Ohlin model derives comparative advantage from differing relative abundances of capital and labour between countries ...
Ricardian Economics - Comparative Advantage
... devised an idea that is well known as the theory of comparative advantage (Henderson 827, Fesfeld 325) ... According to the Washington Council on International Trade, comparative advantage is the ability to produce a good at a lower cost, relative to other goods, compared to another ... In the Principles of Economics, Ricardo states that comparative advantage is a specialization technique used to create more efficient production (52) and describes opportunity cost between producers (53) ...
Comparative Advantage - Considerations - Free Mobility of Capital in A Globalized World
... voiced concern over the applicability of Ricardo's theory of comparative advantage in light of a perceived increase in the mobility of capital "International trade (governed by comparative ... The economist Paul Craig Roberts notes that the comparative advantage principles developed by David Ricardo do not hold where the factors of production are internationally mobile ... expands from one good to multiple goods, the absolute may turn to a comparative advantage ...
Export-led Growth - Limitations
... also criticized for its lack of product diversity as economies pursue their comparative advantage, which makes the economies potentially unstable if demand for their ... This is true of many economies aiming to exploit their comparative advantage in primary commodities as they have a long term trend of declining prices, noted in the Singer-Prebisch thesis though there are ... Also to exploit a potential comparative advantage requires a significant amount of investment which governments can only supply a limited amount of ...

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