Last editedNov 20202 min read
The term comparative advantage is most often attributed to the British economist, David Ricardo. Ricardo’s comparative advantage theory explains the benefits of international trade by pointing out the significance of relative opportunity costs in producing products for different markets. Put another way, Ricardo looked at how efficiently each country was able to produce each product and the overall benefits that this could bring to the trade market.
How does comparative advantage theory work in economics?
Comparative advantage often gets confusing when we talk about the countries that can most efficiently produce multiple products. This doesn’t mean that they have a comparative advantage in various products, however. Instead, it is essential to look at the benefits on a broader scale. Suppose there is a larger efficiency gap between two producers in relation to one product than there is with another. In that case, work should be divided up to allow the maximum overall production level, giving you the best possible cost.
The principle of comparative advantage in international trade
Comparative advantage is typically used with international trade to quantify the benefits of importing and exporting products from particular countries. Again, it does not necessarily mean that the most efficient country will always take the lead. If one country is the strongest producer of multiple products, the comparative advantage theory would suggest they should focus on the product in which they have the greatest advantage. Other countries can take over the production of other products, freeing up time and labour.
What factors influence comparative advantage?
Several different factors influence comparative advantage. Often, things like the cost of land and labour are top of the list, but it’s also vital to consider capital and the abundance of any necessary materials or other goods in a country. Productivity, speed, and efficiency also play a role – although these factors can sometimes be more difficult to quantify on a broad scale.
What is the difference between comparative advantage and absolute advantage?
Typically, absolute advantage (sometimes referred to as competitive advantage) is a simpler calculation than comparative advantage. It differs from comparative advantage in that it’s only concerned with the individual country’s ability to produce a particular good more effectively or efficiently. Whereas absolute advantage can be used to measure an organisation or country’s strength in its market, comparative advantage requires you to consider the respective benefits of choosing one product over another.
How do countries benefit from comparative advantage?
Comparative advantage can benefit all players in the market – both by making goods available at the best possible quality and the best quality price, and by allowing each country to focus its resources on the product that is going to yield the best results. As a theory, comparative advantage encourages international trade and can be used to support the import/export model.
Critics of the comparative advantage theory
Although comparative advantage theory can look confusing to students and business owners, it has been criticised by some as being too simplistic. Typically, the theory only accounts for labour costs, and treats other costs as homogenous. Critics have suggested that this is not applicable to the working world, as it does not account for real-life fluctuation and inconsistencies. In relation to international trade, it has also been said that the theory does not take into account the cultural specificity of different markets around the world, with regard to preferences and income brackets.
We can help
GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.