comparative-advantage

What Is A Comparative Advantage? The Comparative Advantage In A Nutshell

Comparative advantage was first described by political economist David Ricardo in his book Principles of Political Economy and Taxation. Ricardo used his theory to argue against Great Britain’s protectionist laws which restricted the import of wheat from 1815 to 1846.  Comparative advantage occurs when a country can produce a good or service for a lower opportunity cost than another country.

Understanding comparative advantage

To better understand the rationale behind comparative advantage, one must first understand the concept of opportunity cost. An opportunity cost is simply the potential benefit that is relinquished when one option is selected over another. 

In the context of comparative advantage, the opportunity cost for a nation is the cost required to produce a good or service. The nation with the lowest opportunity cost, or the one able to produce a good or service for the lowest price, is the nation holding a comparative advantage. 

Ricardo used his theory to argue that free trade was viable even when one partner in the deal held an absolute advantage in all areas of production. In other words, where one nation could produce goods and services more cheaply and more efficiently than its trade partner. 

The primary concern for nations undertaking free trade is that they will be outproduced by a country with an absolute advantage in most areas, resulting in many imports but no exports. To that end, the theory stipulates that a nation should specialize in exports where it enjoys a comparative advantage and import any good or service where it does not. Specializing in this way means the country can channel additional labor, capital, and natural resources to strengthen its advantage in a given market.

Comparative advantage examples

Comparative advantage can be seen in the following examples:

Call centers

Many Western companies relocate customer support call centers to India because it is cheaper than operating them in their own countries. While many customers experience miscommunication issues with support staff due to the language barrier, the cost of operating these foreign centers is so low that the opportunity cost for the company remains viable. Indeed, the company may use the savings derived from low-cost call centers to then provide cheaper internet or phone services to consumers.

Oil producers

Nations such as Saudi Arabia, Kuwait, and Mexico have a comparative advantage in chemical production since many of the raw materials required to synthesize chemicals are produced when oil is distilled. This makes the chemicals inexpensive to produce, which reduces opportunity costs.

Food production

Ireland has a long-established comparative advantage in producing milk, cheese, butter, and grass-fed beef. This is because the country enjoys a relatively wet climate and has a large amount of arable land suitable for grazing. Ireland has also invested heavily in these exports via the Origin Green program to educate producers on environmentally sustainable farming and food production. This investment makes Ireland’s food and drink products sought after globally and reinforces its comparative advantage. 

Key takeaways:

  • Comparative advantage occurs when a country can produce a good or service for a lower opportunity cost than another country. In this context, the opportunity cost for a nation is the cost required to produce a good or service.
  • Comparative advantage was popularised by economist David Ricardo, who suggested that a nation should specialize in exporting goods that it could produce for the lowest cost and import any goods or services where it could not.
  • Comparative advantage can be seen in the way some companies operate customer support call centers in India and then use cost savings to offer cheaper products to consumers. Comparative advantage can also be seen in Irish food exports and chemical production in oil-rich nations.

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