DEFINITION: “Comparative advantage” refers to an economy’s relative level of productivity. More specifically, it refers to the ability to produce some good or service more efficiently—i.e., at a lower cost—than other countries.
The concept of comparative advantage is instrumental for understanding the how international trade can be mutually advantageous for countries that are trading partners.
Basically, if my country produces cotton more efficiently than yours and your country produces sugar more efficiently than mine, then it is obviously good for us both if we trade cotton for sugar and vice versa.
ETYMOLOGY: The English word “comparative” is attested from the fifteenth century. It derives from Middle English comparen, via Middle French comparer and, ultimately, Latin comparare (to compare).
“Advantage” derives from the word avantage, which is the same in Middle English and Middle French. Avantage, in turn, is formed from the French adverb avant, meaning “before.”Thus, “advantage”basicallymeans “beforeness,” that is, priority or superiority.
USAGE: Historically, the concept of comparative advantage is commonly associated with English political economist David Ricardo, who introduced it in his 1817 work, On the Principles of Political Economy and Taxation. However, it is probable that Ricardo had learned of the concept from his mentor, James Mill.
Comparative advantage is a cornerstone of modern economic theory. It is a principle that elegantly illustrates the fundamental belief—which underlay the political activism of the nineteenth-century advocates of free trade—that the free market, whether domestic or international, can operate to the mutual benefit of all participants.
To understand the principle of comparative advantage, it is necessary to have a firm grasp of the concept of opportunity cost.
“Opportunity cost” refers to the potential benefits of the actions that one does not take. That is, they are benefits that one might have enjoyed but which one forgoes whenever one chooses one course of action over another.
With respect to the economic principle of comparative advantage, to say that one company has a lower opportunity cost than another one means that it gives up fewer potential benefits.
In the context of economics, if not in other realms of life, benefits may be discussed in terms of dollars and cents. For this reason, it will be the company that can produce its trading goods at the lowest cost which will enjoy a comparative advantage over its trading partners with respect to those goods.
The money that the company saves through its more-efficient production may be translated into the terminology of “lower opportunity costs.” That is to say, more opportunities may be pursued with the extra money.
Another way of thinking about comparative advantage is as the optimal choice among all possible trade-offs in a given set of circumstances.
That is, in a situation in which two options are being considered, each of which presents a mix of benefits and drawbacks, the one offering the most benefits and the fewest drawbacks may be said to possess the “comparative advantage.”
The concept of comparative advantage is familiar from everyday life, though not usually under than name. For example, if one possesses certain skills, one will usually attempt to find work in the field in which those skills provide one with the greatest comparative advantage.
For example, an engineer might choose to work for a private firm rather than for the government.
By parity of reasoning, a group of people with diverse skills creates more opportunities for advantageous trade based on the principle of comparative advantage.