Comparative Advantage

Intermediate

Comparative advantage is the ability of a country, business or person to produce a good or service at a lower opportunity cost than others, meaning they give up less of other things to produce it.

The idea, developed by economist David Ricardo in the early nineteenth century, explains why trade can benefit everyone involved, even when one party is better at producing everything.

For example, suppose Country A can produce either 10 cars or 20 tonnes of wheat with the same resources, while Country B can produce either 2 cars or 10 tonnes of wheat. Country A is better at producing both. But for Country A, each car costs 2 tonnes of wheat, while for Country B, each car costs 5 tonnes. Country A has a comparative advantage in cars, and Country B, where a tonne of wheat costs only a fifth of a car instead of half a car, has a comparative advantage in wheat.

If each country specialises in what it produces at the lowest opportunity cost and they trade, total output increases and both can end up with more than they could produce alone.

Comparative advantage is a foundation of the case for free trade. In practice, the gains from trade are not always evenly distributed within countries, and some workers and industries may lose out when trade increases.

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