Absolute and Comparative Advantage: Explanation & Examples
Absolute and comparative advantage
Absolute and comparative advantage is a theory created by David Ricardo that explains how efficient countries are producing goods and services in relation to other countries.
Absolute advantage is the capacity to produce goods and services than other countries and comparative advantage is the capacity to produce goods and services at a lower opportunity cost, which is the benefit lost when selecting an option over another
According to this theory, each country should specialize in producing and exporting goods and services whose production costs are lower and imply more efficiency, and import or bring from abroad goods whose production is more expensive. The goal is to reduce expenses by bringing them from the other country through international trade.
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David Ricardo’s Theory of Comparative Advantage
David Ricardo’s theory states that countries will produce and export goods whose production has a lower cost and are their specialty and will import goods whose production would be very expensive, therefore, better to bring them from abroad.
Ricardo states that specialization is something that benefits all trading partners and even those countries with less efficient production in relative terms, because real costs increase even in the countries that are more efficient in absolute terms, this is explained below.
Types advantages
David Ricardo’s theory states that there are two types of advantages, absolute advantage and comparative advantage.
Absolute advantage
Absolute advantage is when one country has an advantage over another because it uses fewer resources to produce a product.
For example, a country has an absolute advantage if it produces wheat and has a better climate to do so and its labor force is more productive than another country that produces that same product.
Comparative advantage
A country has a comparative advantage producing a good if it can produce it at a lower cost in terms of other goods, or in other words, when the opportunity cost is lower.
An example is a country that has an absolute advantage because it has a better climate, a larger labor force and lower production costs and has the options of producing corn and wheat. In order produce wheat this country must give up two tons of corn, while another country must give up only one, the latter has a comparative advantage.
The second country, despite not having an absolute advantage, only has to give up one ton of corn to produce wheat. In short, the comparative advantage belongs to the country that has to give up less corn.
Opportunity cost
The opportunity cost is the sacrifice or alternatives that must be given up by choosing one option and not another.
Comparative advantage means lower opportunity cost, for example, the opportunity cost of cotton is the wheat that must be sacrificed to obtain the hectares to plant cotton.
The cost of three (03) bales of cotton in New Zealand is three (03) barrels of wheat, but the cost of three (03) bales of cotton in Australia is only one barrel of wheat. Australia has a comparative advantage over New Zealand in cotton production.
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