Comparative Advantage - Explained
What is Comparative Advantage?
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What is Comparative Advantage?
Comparative advantage refers to the capacity of a country to produce goods and services at an opportunity cost rate lower than other countries. Since the goods and services are produced at lower costs, they are also sold at lower prices. A country that is at a comparative advantage also realizes more profits and stronger sales margin when compared to other countries that produce similar goods and services. David Ricardo, a political economist developed the term 'Comparative Advantage' in his book "Principles of Political Economy and Taxation. When a country performs an economic activity in a more effective and efficient ways than other countries, the country is at comparative advantage.
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How Does Comparative Advantage Work?
Comparative advantage is a key concept in the theory of global or international trade. James Mill was said to have originated the comparative advantage analysis but it was developed by his mentee David Ricardo. The comparative advantage concept holds that all actors can mutually benefit from a trade when there is cooperation. Opportunity cost is a crucial term to comparative advantage. A country that is able to produce goods at a lower opportunity cost has a comparative advantage over other countries that cannot. There are other potential benefits that an economy can forfeit due to the failure to produce at a lower opportunity cost, this include stronger sales margins and lower prices of goods. An absolute advantage is when a country of a firm produces a greater number of goods (commodities) and services and at a better quality when compared to other countries using less quantity of inputs. Comparative advantage on the other hand means producing goods and services at a lower opportunity cost. Comparative advantage does not deal with quantity and quality but with the opportunity cost used, while absolute advantage places a premium on the ability to produce more and better goods using the same resources. This is the major difference between the two terms. A competitive advantage refers to the ability of a company, country or individual to outshine or outperform other countries or companies that produce similar goods and services, otherwise known as its competitors. When a company offers greater value in terms of goods and services to its customers, the company occupies a superior position when compared to other firms that produce the same goods. Although, competitive advantage is a bit similar to comparative advantage, they are different terms because comparative advantage is based on lower use of opportunity cost while competitive advantage premises on provision of greater value. For a company to have competitive advantage over other competitors, it must;
- provider goods or services at low-cost,
- Offer superior goods or services with greater value than its competitors, and
- focus on a specific segment of production.
International trade involves exchanges of goods and services between different countries. Ordinarily, countries have specialized years they are known for, some specialize in production of automobiles, some machinery and equipment, some fabrics, and many more. Comparative advantage plays an important role in putting a country at an advantage over other countries with similar products. For instance, if England produce fabric cheaply than other countries, it will offer the goods at low cost and have a stronger sales margin than other countries that produce this item, this is comparative advantage. In an international trade, a country then decides to have a trade partner with a comparative advantage. Diversity of skills is a key proponent that helps individuals realize jobs or skills they are comparatively best at. For instance, a worker who earns more as a cloth maker than a cobbler has a comparative advantage of he practices as a cloth maker than as a cobbler. Comparative advantage holds that the more people are diversified in their skills, the more opportunity they have. Opportunity costs is linked to an organized and a more efficient labor. Comparative advantage also help individuals with diversified skills form trade arrangement with mutual benefits based off the services they are best at.
- Self Interest
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- Fisher's Separation Theorem
- Ratchet Effect
- Total Utility (Economics)
- Efficiency Principle
- Expected Utility
- Subjective Theory of Value
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- Indifference Curve
- Time Preference Theory of Interest
- Marginal Benefit
- Diminishing Marginal Utility
- Sunk Costs
- Production Possibilities Frontier
- Law of Diminishing Returns
- Economic Efficiency
- Efficiency Theory
- Productive Efficiency
- Capacity Utilization Rate
- Allocative Efficiency
- Pareto Efficient
- Comparative Advantage
- Criticisms of the Economic Approach
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- Invisible Hand
- Sunk cost