Comparative Advantage

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Definition of a Comparative Advantage:

A comparative advantage is an advantage gained when a person, company, or country can produce a particular good or service at a lower opportunity cost than another producer.

Detailed Explanation:

Trade enables companies and countries to benefit by focusing on their specialty. Companies spend their resources developing specialties that give them a comparative advantage over their competition. Companies should focus on what they do best and rely on trade to help achieve their goals. A country’s resources provide the means to develop its comparative advantage in the production of a good or service, although a country may not have an absolute advantage in the production of any good. A country’s prosperity will be greater if it concentrates on producing the good it has the comparative advantage in and trades for other goods.

Absolute and comparative advantage are frequently confused. The following example illustrates the difference. 

Assume that Joseph and Victoria are dentists.  The table below shows their daily production possibilities for filling cavities and completing bridgework. This means that Victoria is able to complete a maximum of four bridges in one day if she just did only bridgework. If she did only cavities she could fill 20 in a day. If Joseph completed 12 bridges in a day he would not be able to fill any cavities, and 24 cavities if he neglected the bridges.

chart showing example of comparative advantage

Victoria can produce only 4 bridges per day, while Joseph can produce 12.  Joseph is clearly the more efficient producer of bridges, so he has the absolute advantage in bridgework. Joseph is also more efficient at filling cavities. He can fill 24 per day while Victoria can only fill 20. Therefore Joseph also has an absolute advantage in cavity work.

However, Victoria has a 
comparative advantage in filling cavities. Why? Because her opportunity cost to fill a cavity is less than Joseph's. When Victoria fills a cavity she gives up the opportunity to complete .2 bridges (4 / 20).  Therefore her opportunity cost for cavities is .2 bridges. Joseph's opportunity cost for cavities equals .5 bridges. When Joseph fills a cavity he gives up the opportunity to complete .5 bridges (12 / 24). Victoria has the comparative advantage in cavity work because her opportunity cost of .2 is less than Joseph's of .5. Joseph has the comparative advantage in bridgework. Joseph gives up the opportunity to fill 2 cavities if he constructs a bridge (24/12). Victoria gives up the opportunity to fill 5 cavities for every bridge, so her opportunity cost is 5. Clearly, Joseph has the lower opportunity cost and the comparative advantage in bridgework. This means that Joseph should specialize in bridgework while Victoria should focus on cavities. The productivity would improve after merging the two practices if each dentist specialized in the area they have the comparative advantage. Assume that in a typical 8 hour day Joseph completes six bridges and twelve cavities. (It takes Joseph .67 hours to complete a bridge, and .33 hours to fill a cavity.) Victoria is not as productive, but she is able to complete three bridges and five cavities in a typical day. (Bridges take Victoria two hours and cavities take her .4 hours.) If Joseph and Victoria formed a partnership and Joseph specialized in bridges and Victoria specialized in cavities they could complete all of the work in a total of 12.8 hours. In the remaining 3.2 hours, they could each generate added income for their new practice!

Today, specialization has become more prominent. When we tear a ligament, we seek an orthopedic surgeon, not a general practitioner. A professional orchestra seeks a musician specializing in the violin rather than a talented musician who plays several instruments fairly well.  You would not hire someone who fixes your car to fix your computer. In each case, we seek the services of specialists.  

Each of us has gifts, whether they are material, mental, or physical. These gifts provide us with the ability to specialize. The specialty you choose will depend on your resources and passions. Those same resources and passions will provide you with a comparative (not necessarily an absolute) advantage over other people entering the workforce. Good luck!

Here's a fun video explaining this concept more.

Dig Deeper With These Free Lessons:

Comparative Advantage And Specialization
Production Possibilities Frontier
Fundamental Economic Assumptions
Opportunity Cost – The Cost of Every Decision
Managing Supply Using Outsourcing, Tariffs, Subsidies, Quotas & Licenses

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