A country can produce a good or service at a lower opportunity cost than the other country Show
What is a Comparative Advantage?In economics, a comparative advantage occurs when a country can produce a good or service at a lower opportunity cost than another country. The theory of comparative advantage is attributed to political economist David Ricardo, who wrote the book Principles of Political Economy and Taxation (1817).  Ricardo used the theory of comparative advantage to argue against Great Britain’s protectionist Corn Laws, which restricted the import of wheat from 1815 to 1846. In arguing for free trade, the political economist stated that countries were better off specializing in what they enjoy a comparative advantage in and importing the goods in which they lack a comparative advantage. What is an Opportunity Cost?To understand the theory behind a comparative advantage, it is crucial to understand the idea of an opportunity cost. An opportunity cost is the foregone benefits from choosing one alternative over others. For example, a laborer can use one hour of work to produce either 1 cloth or 3 wines. We can think of opportunity cost as follows: What is the forgone benefit from choosing to produce one cloth or one wine? Therefore:
Comparative Advantage and Free TradeComparative advantage is a key principle in international trade and forms the basis of why free trade is beneficial to countries. The theory of comparative advantage shows that even if a country enjoys an absolute advantage in the production of goods, trade can still be beneficial to both trading partners. Practical Example: Comparative AdvantageConsider two countries (France and the United States) that use labor as an input to produce two goods: wine and cloth.
The information provided is illustrated as follows: It is important to note that the United States enjoys an absolute advantage in the production of cloth and wine. With one labor hour, a worker can produce either 20 cloths or 20 wines in the United States compared to France’s 5 cloths or 10 wines.
To determine the comparative advantages of France and the United States, we must first determine the opportunity cost for each output: France:
The United States:
When comparing the opportunity cost of 1 cloth for both France and the United States, we can see that the opportunity cost of cloth is lower in the United States. Therefore, the United States enjoys a comparative advantage in the production of cloth. Additionally, when comparing the opportunity cost of 1 wine for France and the United States, we can see that the opportunity cost of wine is lower in France. Therefore, France enjoys a comparative advantage in the production of wine. Comparative Advantage and its Benefits in Free TradeHow does identifying each country’s comparative advantage aid in understanding its benefits in free trade? First, let’s assume that the maximum amount of labor hours is 100 hours. In France:
In the United States:
Following Ricardo’s theory of comparative advantage in free trade, if each country specializes in what they enjoy a comparative advantage in and imports the other good, they will be better off. Recall that:
In France, the country specializes in wine and produces 1,000 barrels. Recall that the opportunity cost of 1 barrel of wine in the United States is 1 piece of cloth. Therefore, the United States would be open to accepting a trade of 1 wine for up to 1 piece of cloth. The potential gains from trade for Europe by specializing in wine is represented by the arrow: In the United States, the country specializes in cloth and produces 2,000 pieces. Recall that the opportunity cost of 1 piece of cloth in France is 2 barrels of wine. Therefore, France would be open to accepting a trade of 1 cloth for up to 2 barrels of wine. The potential gains from trade for the United States by specializing in cloth is represented by the arrow: Therefore, using the theory of comparative advantage, a country that specializes in their comparative advantage in free trade is able to realize higher output gains by exporting the good in which they enjoy a comparative advantage and importing the good in which they suffer a comparative disadvantage. Related ReadingsThank you for reading CFI’s guide to Comparative Advantage. To keep advancing your career, the additional CFI resources below will be useful:
When a country can create products at a lower cost than other countries?3. Comparative advantage occurs when a country can produce goods and services at lower costs than other nations. Comparative advantage occurs when a country can produce something with lower opportunity costs than other nations. Lower costs would be an example of absolute advantage.
When a country can produce more of a good than other country?Comparative advantage takes a more holistic view of production. In this case, the perspective lies in the fact that a country or business has the resources to produce a variety of goods and services rather than focus on just one product.
When one nation can produce a product at lower cost?In economic terms, a country has a comparative advantage when it can produce at a lower opportunity cost than that of trade partners. While a country cannot have a comparative advantage in all goods and services, it can have an absolute advantage in producing all goods.
What does it mean for a country to have an absolute advantage?Absolute advantage is the ability of an individual, company, region, or country to produce a greater quantity of a good or service with the same quantity of inputs per unit of time, or to produce the same quantity of a good or service per unit of time using a lesser quantity of inputs, than its competitors.
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