In international trade, no country can have a comparative advantage in the production of all goods or services. 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.
Comparative Advantage vs. Absolute Advantage
The difference between a comparative advantage and an absolute advantage has to do with production costs, quality, and efficiency. The idea of comparative advantage is attributed to English political economist David Ricardo and his book On the Principles of Political Economy and Taxation. When a country has a comparative advantage in producing certain items, it means the nation can make the products at a lower cost than other countries.
- A comparative advantage exists when a country can produce goods at lower opportunity cost compared to other countries.
- It is not possible for a country to have a comparative advantage in all goods.
- However, a country can have an absolute advantage in all goods.
- An absolute advantage exists when a country is simply the best (most efficient) in producing a product or service.
- It is in the best interest of countries to produce the goods and services in which they have the highest comparative advantage.
A key to the understanding the concept of comparative advantage is a solid grasp of the idea of opportunity cost, which is the potential benefit that is lost when selecting a particular option over another. The country with the lowest opportunity costs associated with producing a good or service has the greatest comparative advantage.
On the other hand, a country that has an absolute advantage with respect to specific goods is simply the best at producing those items. The idea was developed by Adam Smith in the book Wealth of Nations and the concept states that a country can benefit from trade by specializing in producing and exporting the goods that they produce more efficiently than other countries. However, just because a country produces certain goods better and more quickly than other countries does not mean the country can make them at a lower cost.
In international trade, both parties benefit from commerce with other countries because each country has advantages in producing certain goods or services. Trade among nations makes the global marketplace more competitive, and the increased competition results in less expensive products for consumers. It is in the best interest of countries to promote industries in which they have the highest comparative advantage.
In fact, the law of comparative advantage states that free trade works even if one country ends up with an absolute advantage in producing all products or in all aspects of producing a good or service because other countries would still have comparative advantages in the production of some goods or services. These countries would, therefore, be able to sell those goods or services at lower costs than the country with the absolute advantage.