The Principle of Comparative Advantage and Its Economic Definition

Comparative advantage Beside absolute advantage, comparative advantage is another concept that everyone should know well since it plays an important role in trade. Comparative advantage is the ability of an individual, a firm or a country to produce a good or service at a lower opportunity cost, which is the highest valued alternative that is given to engage in an activity, than competitor. An important economic principle that everyone knows is: The basis for trade is comparative advantage, not absolute advantage. But why? This following example will help us answer that question. There are two men lost in an isolated island. To survive, they have to look for food and drink, make shelter and so on. The first man is young, strong and active so he can catch fish and make shelter more effectively. This is his absolute advantage. The other man is old and weak. He can only do simple things such as gather fruit or look more fresh water. Obviously, his advantage compared with the young man is lower. However, their own absolute advantage can’t help them survive. They have to work together. The young man can fish and make shelter, while the old man looks for fruit and water. By doing this, each of them specializes in some works for which they have a comparative advantage and obtain the goods they need by trading. The next example will show us more clearly how comparative advantage helps us gain more from trade. Imagine that you and your neighbor both have the same number of apple trees and cherry trees. You can pick 5 pounds of apple and 8 pounds of cherries after the first week. While your neighbor picks 3 pounds of apple and 10 pounds of cherries. So apple is your absolute advantage and cherries is your neighbor’s absolute advantage. If you focus on picking only apple, you can have 15 pounds of apple in the second week. Your neighbor does the same thing as you, he will have 20 pounds of cherries and he decides to trade 2 pounds of cherries to get 1 pound of your apple. After trade, you will have 10 pounds of apple and 10 pounds of cherries. Your neighbor has 5 pounds of cherries and 10 pounds of cherries. Compare to the first week, both of you are better off. Understanding clearly comparative advantage is very useful to take advantage in trade.