Comparative Advantage

What Is Comparative Advantage?

Comparative advantage is the ability to produce a good or service at a lower opportunity cost than a trading partner can. The concept was formulated by the economist David Ricardo in his 1817 book On the Principles of Political Economy and Taxation, using the famous example of England and Portugal producing cloth and wine. Comparative advantage is not the same as being the most productive: a country that holds an absolute advantage in both goods can still gain from trade, as long as the two countries face different opportunity costs. Whichever country gives up less of one good to make another is said to have the comparative advantage in that good, and should specialize in producing it.

Why It Matters

Comparative advantage explains why trade can leave both partners better off, even when one is more efficient at everything. In the classic two-country, two-good model, each nation specializes in the good for which its opportunity cost is lower and trades for the rest, raising combined output. Through trade, a country can then consume at a point beyond its own production possibilities curve, something it could never reach in isolation. In an AP Macroeconomics output problem, opportunity cost is found by dividing the other good's output by the good in question ('other over own'); in an input problem it is 'own over other.' Comparative advantage remains the foundational argument for why specialization and exchange expand the total economic pie.

Test Your Knowledge

Questions on this topic from the EconRecall fact bank:

• Which economist is credited with formulating the theory of comparative advantage in 1817?
  David Ricardo
• In which 1817 book did David Ricardo lay out the theory of comparative advantage?
  On the Principles of Political Economy and Taxation
• Comparative advantage is determined by which country can produce a good at the lowest what?
  Opportunity cost