The Magic of Comparative Advantage in the Economy

Every economy in the world has its own special characteristics that separate countries from one another. Countries have their respective approaches in running their economies, may it be traditional, command, market economic or mixed.

Although four or five nations may apply the same approach, some economies perform better than others, which give them a sizeable lead in the global market.

Truly no single country is best in producing everything. This is where the role of comparative advantage takes effect, which is crucial in determining the prices of the goods involved.

Vanishing Opportunity

There are times in our everyday lives that we are able to explore a specific thing but forego another. This is the same with the countries producing goods and service. There is an amount of goods or services that is sacrificed to produce another type of product or service, known as the opportunity cost. And from this opportunity cost, the country’s comparative advantage can be determined.

In the international trade theory, comparative advantage means producing a commodity at a lesser opportunity cost than other entities.

This theory originated from the economist, David Ricardo, and was widely accepted as a fundamental factor to determine the pattern of trade among nations. Ricardo believed that a country should produce a product where they have a comparative advantage, and this means being more cost efficient than other country and losing potential gain when one alternative is chosen.

Laying the Cards

The concept of comparative advantage is rally confusing so it is best explained through examples.

Ricardo observed in 1871 that Portugal has less labor in producing both wine and cloth compare to England but the latter can produce cloth much better. Therefore, the English country should produce cloth and import wine from Portugal.

Another example is Switzerland’s comparative advantage in producing chocolates, where the country is best known. Say the country can create one pound of cheese and two pounds of chocolates in a single hour so if it chooses to produce one choose, it will lose two chocolates and vice versa. In this case, the country can benefit from producing two pounds of chocolate because it will just give up one pound of cheese.