comparative advantage

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Comparative advantage

Theory suggesting that specialization by countries can increase worldwide production.

Comparative Advantage

The ability of an individual, company, or economy to conduct an activity better than another for some fixed, almost unchangeable reason. Comparative advantage is important in making decisions such as what products one should make or sell; if a company is unable to make a product as well as another and that is unlikely to change, the company might be well advised to make a different product. For example, a lumber company in Oregon has a comparative advantage to a lumber company in Arizona because there are simply more trees in Oregon. This makes it unlikely that the company in Arizona will be able to fill orders as well or as quickly as the company in Oregon. For this reason, the Arizona company's management might consider investing in mining instead of lumber.

comparative advantage

Comparative advantageclick for a larger image
Fig. 24 Comparative advantage. The physical output of X and Y from a given factor input, and the opportunity cost of X in terms of Y. The opportunity cost of producing one more unit of X is 1Y in country A, and 2/3 Y in country B. The opportunity cost of producing one more unit of Y is 1X in country A, and 11/2X in country B.

comparative advantage

the advantage possessed by a country engaged in INTERNATIONAL TRADE if it can produce a given good at a lower resource input cost than other countries. Also called comparative cost principle. This proposition is illustrated in Fig. 24 with respect to two countries (A and B) and two GOODS (X and Y). The same given resource input in both countries enables them to produce either the quantity of Good X or the quantity of Good Y indicated in Fig. 24. It can be seen that Country B is absolutely more efficient than Country A since it can produce more of both goods. However, it is comparative advantage not ABSOLUTE ADVANTAGE that determines whether trade is beneficial or not. Comparative advantage arises because the marginal OPPORTUNITY COSTS of one good in terms of the other differ as between countries (see HECKSCHER-OHLIN FACTOR PROPORTIONS THEORY).

It can be seen that Country B has a comparative advantage in the production of Good X for it is able to produce it at a lower factor cost than Country A; the resource or opportunity cost of producing an additional unit of X is only 2/3 Y in Country B, whereas in Country A it is 1Y .

Country A has a comparative advantage in the production of Good Y for it is able to produce it at lower factor cost than Country B; the resource or opportunity cost of producing an additional unit of Y is only 1X, whereas in Country B it is 11/2X.

Both countries, therefore, stand to increase their economic welfare if they specialize (see SPECIALIZATION) in the production of the good in which they have a comparative advantage (see GAINS FROM TRADE for an illustration of this important proposition). The extent to which each will benefit from trade will depend upon the real terms of trade at which they agree to exchange X and Y.

A basic assumption of this presentation is that factor endowments, and hence comparative advantages, are ‘fixed’. Dynamically, however, comparative advantage may well change. It may do so in response to a number of influences, including:

  1. the initiation by a country's government of structural programmes leading to resource redeployment. For example, a country that seemingly has a comparative advantage in the supply of primary products such as cotton and wheat may nevertheless abandon or de-emphasize it in favour of a drive towards industrialization and the establishment of comparative advantage in higher value-added manufactured goods;
  2. international capital movements and technology transfer, and relocation of production by MULTINATIONAL COMPANIES. For example, Malaysia developed a comparative advantage in the production of natural rubber only after UK entrepreneurs established and invested in rubber-tree plantations there. See COMPETITIVE ADVANTAGE (OF COUNTRIES).
References in classic literature ?
I left that enquiry and turned away to consider whether justice is virtue and wisdom or evil and folly; and when there arose a further question about the comparative advantages of justice and injustice, I could not refrain from passing on to that.
Bender, Siegfried and Kui-Wai Li (2002) The Changing Trade and Revealed Comparative Advantages of Asian and Latin American Manufacture Exports.
Lin stressed that the rapid and sustainable growth needs to be boosted by governments' right policy frameworks to facilitate the development of the private sector along the lines of the country's comparative advantages and to tap into the latecomer advantages.
The Normalized Revealed Comparative (NRCA) indices of traditional jute products reveal that India still enjoys comparative advantages and shows a rising trend in the case of diversified jute products.
The minister also deplored the fact that the sector of industry contributes only by 5% to 6% in the gross domestic product (GDP), despite Algeria's "tremendous comparative advantages.
Exploiting these comparative advantages through bargaining can improve the outcomes of economic development projects.
We rewriting the formulas from the deducted algorithm of the simple barter case (Dogaru, 2006) for a more exact approximation of the comparative advantages of the two economic entities, through taking in consideration the different clauses which involves external costs, excluded in the initial prices considered in this basic scheme.
Hertz is no less clear about the origin of the rich-poor gap--the comparative advantages cumulatively developed in the regions best endowed with natural assets; the systems and structures, economic and financial, which their populations devise to maintain and reinforce their advantages; the distribution of power which enables them to stay in that position despite the obvious inequality on which it rests.
Given its natural endowments and comparative advantages, it is critical for Belize to adopt an approach that seeks to make the most of the opportunities from both the Caribbean and Latin America in a fashion that allows it to realize its development objectives," she said, "while allowing each sub-region to be able to realize and benefit from a stronger interregional relationship.
Therefore, market-led and state-led approaches differ fundamentally on a crucial point: the market-led approach assumes that countries are assigned certain comparative advantages within which developing nations should work, while the state-led approach seeks to shape the comparative advantage that they have to use in the international economy.
With prices often higher for an on-sire shredding operation, companies are weighing the comparative advantages of both procedures.
Local authorities are trying to lure more business to the city by promoting Kobe's key selling points, such as its international infrastructure, its role as a distribution hub, the strong presence of pharmaceutical firms and other areas where it has comparative advantages, such as in environment-related technology and clothing fashion.

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