key term - Comparative Advantage

Definition

Comparative advantage is the ability of an individual or country to produce a particular good or service at a lower opportunity cost than another. It is a key concept in the theory of international trade, as it explains how countries can benefit from specializing in the production of goods and services where they have a comparative advantage, and then engaging in trade.

5 Must Know Facts For Your Next Test

1. Comparative advantage allows countries to benefit from trade even if one country has an absolute advantage in the production of all goods.
2. Specialization and trade based on comparative advantage lead to increased productivity and higher standards of living for all trading partners.
3. A country has a comparative advantage in producing a good if it can produce that good at a lower opportunity cost than another country.
4. Comparative advantage is determined by differences in production technologies and resource endowments between countries.
5. Trade based on comparative advantage enables countries to consume more of all goods than if they were self-sufficient.

Review Questions

• Explain how comparative advantage differs from absolute advantage and how it leads to gains from trade.
  • Comparative advantage refers to a country's ability to produce a good at a lower opportunity cost compared to another country, even if it does not have an absolute advantage in producing that good. This means a country can still benefit from trade by specializing in the goods where it has a comparative advantage, rather than trying to be self-sufficient in all goods. By specializing and trading, both countries can consume more of all goods than if they were self-sufficient, leading to gains from trade.
• Describe how differences in production technologies and resource endowments between countries can create comparative advantages.
  • Differences in production technologies and resource endowments between countries are the fundamental drivers of comparative advantage. For example, a country with abundant arable land and favorable climate may have a comparative advantage in agricultural products, while a country with advanced manufacturing capabilities may have a comparative advantage in producing machinery and electronics. These differences in resource availability and productivity allow countries to specialize in the goods where they have a lower opportunity cost of production, leading to increased efficiency and gains from trade.
• Evaluate how specialization and trade based on comparative advantage can improve a country's standard of living in the context of 19.2 Improving Countries' Standards of Living.
  • In the context of 19.2 Improving Countries' Standards of Living, specialization and trade based on comparative advantage can be a key driver of economic growth and improved standards of living. By specializing in the production of goods and services where they have a comparative advantage, countries can become more efficient and productive, leading to higher incomes and greater consumption of both domestic and imported goods. This increased productivity and access to a wider variety of products can significantly improve the overall standard of living for the population. Furthermore, the gains from trade allow countries to consume more than they could produce on their own, further enhancing their economic well-being. Ultimately, the concept of comparative advantage and the resulting specialization and trade can be a powerful tool for improving a country's standard of living.

Related terms

Opportunity Cost:

The cost of an alternative that must be forgone in order to pursue a certain action or choice. It's the value of the best alternative given up.

Specialization:

The focus on the production of a limited scope of goods or services in order to become more efficient and productive.

Absolute Advantage:

The ability to produce more of a good with the same amount of resources compared to another producer.