Definition and examples of comparative advantage

Comparative advantage means a nation’s ability to generate a good or service at a lower opportunity cost than other nations. Ricardo has presented the first comparative advantage example using the “production of wine”.

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What Is Comparative Advantage?

Comparative advantage means a nation’s ability to generate a good or service at a lower opportunity cost than other nations. According to the comparative advantage theory, a country may be not the best at producing a good or service but sometimes it may be able to produce this good or service at a lower opportunity cost than other nations.

But the comparative advantage is not only limited to explaining the international trade between countries, it also can explain how individuals and companies get benefits from the trade.

The theory of comparative advantage can be identified as one of the most important economics and one of the fundamental principles of international trade. 

The main understanding of the theory of comparative advantage depends on the opportunity cost.

Opportunity cost can be defined as the value of the losing best option as a result of you selecting an option. In other words, opportunity cost means when we make a decision, the value of the next best option that we lost or we have to give up.

To read more about the opportunity cost, kindly click here

Comparative advantage can also be thought of as the optimal decision given a trade-off. The option with the comparative advantage is the one that offers the best overall package when two alternatives are being compared, each of which has trade-offs (some advantages as well as some disadvantages).

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Theory of Comparative Advantage

At the first time, the theory of comparative advantage was introduced by the famous English political economist, David Ricardo in his 1817 book “On the Principles of Political Economy and Taxation”. Ricardo’s mentor, James Mill, originated this analysis.

High income countries can produce all the goods at a lower cost than low-income countries. Because high income countries abundant with the skilled employees, new technologies, advanced equipment, up-to-data production process.

So, is there any opportunity to still gains from international trade? Yes.
David Ricardo stated that still countries can get mutual benefits, although one country has an absolute advantage in all goods.

For that each country should have comparative advantage to produce one good.

Examples of comparative advantage

The First Example of Comparative Advantage

Ricardo has presented the first example of comparative advantage using the “production of wine”. Ricardo stated that Portugal can produce wine using 80 men labour. Also, Portugal can produce cloth using 90 men labour. England also can produce these two products, but England is less efficient than Portugal to produce these two goods. In other words, Portugal has the absolute advantage of producing these two goods.  However, according to this example by Ricardo, England has a comparative advantage in producing clothes. In other words, England can produce clothes with low opportunity cost. Portugal has a comparative advantage in producing wine. In other words, Portugal can produce wine with low opportunity cost. So in first comparative advantage example, Ricardo has mentioned that Portugal should produce more wine instead of cloth and export wine and import cloth.

A comparative advantage example in real life

Jane is a professional accountant. She can earn $100 per hour working as an accountant. Also, Jane does day-to-day duties in home such as cooking, washing the clothes, and cleaning the house. Usually, she takes an average of 3 hours per day to complete day-to-day duties at the home. So, when Jane scarify three hours to complete day-to-day activities, she lost $300 ($100 per hour working as an accountant for three hours).

Jane’s neighbor Liza works as a waiter in a coffee shop. Liza receives $15 per hour and she works 3 hours per day (Daily income of Liza = $15 x 3 = 45).

Jane asked Liza to complete Jane’s housework and Jane agreed to pay $20 per hour to Liza. As I mentioned above, Jane takes three hours to complete day-to-day activities. Jane pays Liza $60 per day ($20 x 3 = $60).

According to this comparative advantage example, Jane can more efficiently work as an accountant and more efficiently complete housework than Liza. So, Jane has the absolute advantage of completing both two duties. But, both parties can be better off when Liza does the housework for Jane. Because then Jane can earn a net income of $240 by working three hours as an accountant ($300) and pay Liza $60 ($300 – $60).

Liza can earn an extra $15 per day ($60 – $45). Because jane pays Liza $60 per day. The daily income of Liza, if she works as a waiter of the coffee shop, is $15.

This comparative advantage example clearly explains how comparative advantage should be applied in real life.