Category: 

What Are the Benefits of Comparative Advantage?

Article Details
  • Written By: Peter Hann
  • Edited By: Angela B.
  • Last Modified Date: 05 October 2014
  • Copyright Protected:
    2003-2014
    Conjecture Corporation
  • Print this Article
Free Widgets for your Site/Blog
The CDC reported that eight foods, including peanuts and milk, account for 90% of food allergies.  more...

October 25 ,  1971 :  The United Nations expelled Taiwan and admitted China.  more...

The concept of comparative advantage was first formulated by economist David Ricardo as an explanation of the benefits of international trade for countries. His theory concluded that a country could increase its income by specializing in certain products and services and selling these on the international market. Businesses also may have a comparative advantage over their competitors resulting from certain assets, skills or geographical and historical factors. For example, an industry may be in an area where the workforce is specialized in certain skills, or an agricultural business may be situated in an area of rich soil and favorable climate. The benefits of comparative advantage also may apply to people and provide a reason why they should specialize in certain skills rather than others.

Ricardo’s theory of comparative advantage points out that, if a country is relatively efficient at producing certain products then it should specialize in these, even if it does not have an absolute advantage in their production. In other words, even though other countries might produce these goods more efficiently, a country should still specialize in certain goods if the opportunity cost of producing them is lower in that country. The opportunity cost is the cost of the next best use that could be made of the resources devoted to production of the goods. Opting to specialize in goods that it produces comparatively efficiently could help a country to sell more and increase its income.

Ad

The benefits of comparative advantage are that, if the country specializes in those goods in which it is relatively most efficient, then the total national output and, therefore, the national income may be increased. The country can produce more of those goods than it needs and export them to other countries while using export proceeds to purchase imported goods and services that it does not produce. In economists' terms, the country is pushing its production possibility frontier outward and, therefore, increasing its national output. The benefits of comparative advantage may, therefore, result in greater national income.

In the case of a trading company, the benefits of comparative advantage may explain how a company can increase its profits by concentrating on producing those goods and services for which it has a comparative advantage over its competitors. This may mean concentrating on core products and core competencies. The company may be more efficient than its competitors in producing certain items owing to the possession of certain advanced tangible assets or valuable intangible assets. For example, the company may possess certain patents or know-how enabling it to make its processes or products more efficient. Valuable intangible assets could include having experienced management or a skilled workforce in place.

Ad

More from Wisegeek

You might also Like

Discuss this Article

burcinc
Post 3

@ZipLine-- Great example.

The best thing about comparative advantage is that we get a bigger variety of products to choose from as consumers. Comparative advantage also helps out developing countries because it has been shown that trade encourages development.

ZipLine
Post 2

@SarahGen-- It's easier to understand comparative advantage when it's compared to absolute advantage.

In absolute advantage, a country produces and trades a good when it's more efficient at it than any other country. In comparative advantage, countries produce a good that it is more efficient in, when compared to other goods.

So, for example, lets say that we have country A and B. Country A produces berries and oranges more efficiently than country B but it's most efficient in berry production. Country B is less efficient at both when compared to country A, but it is slightly better at producing oranges than berries. According to comparative advantage, country A should produce berries, country B should produce oranges and they should export them to one another.

If we were using absolute advantage, we would have country A produce both berries and oranges. Country B would not be able to export or import either and Country B would only be able to export those goods. So comparative advantage encourages trade and it creates a situation where everyone has something to gain.

SarahGen
Post 1

Comparative advantage is supposed to make trade a win-win situation for all. But how so? Can someone explain this to me?

Post your comments

Post Anonymously

Login

username
password
forgot password?

Register

username
password
confirm
email