key term - Comparative Advantage

Definition

Comparative advantage is an economic principle that describes the ability of an individual, business, or country to produce a particular good or service at a lower opportunity cost compared to another producer. It forms the basis for mutually beneficial trade between different entities.

5 Must Know Facts For Your Next Test

1. Comparative advantage explains why countries should specialize in the production of goods and services in which they have the lowest relative cost, even if they do not have an absolute advantage in all goods.
2. Comparative advantage is a key concept in understanding the benefits of international trade, as it allows countries to maximize their production and consumption through specialization and exchange.
3. The principle of comparative advantage suggests that countries should focus on producing and exporting goods in which they have the lowest opportunity cost, while importing goods in which they have a higher opportunity cost.
4. Comparative advantage can arise from differences in technology, resources, labor skills, or other factors that affect the cost of production between countries.
5. Exploiting comparative advantages through international trade can lead to increased productivity, higher standards of living, and greater overall economic efficiency.

Review Questions

• Explain how the concept of comparative advantage relates to the production possibilities frontier and social choices (as discussed in Chapter 2.2).
  • The production possibilities frontier (PPF) represents the maximum combinations of two goods that an economy can produce given its resources and technology. The principle of comparative advantage suggests that countries should specialize in the production of goods in which they have the lowest opportunity cost, as indicated by the slope of the PPF. By specializing and trading, countries can consume beyond their individual PPFs, leading to greater overall social welfare and consumption choices.
• Describe how comparative advantage and absolute advantage (discussed in Chapter 19.1) are related, and how they impact international trade between countries (as covered in Chapters 19.2, 19.3, and 19.4).
  • Absolute advantage refers to the ability to produce a good using fewer inputs than another producer, while comparative advantage considers the relative cost of production. Even if a country has an absolute advantage in the production of all goods, it can still benefit from trade by specializing in the goods in which it has the lowest relative cost, or comparative advantage. This allows countries to exploit their comparative advantages, leading to increased productivity, lower consumer prices, and greater overall economic efficiency through international trade.
• Analyze how the concept of comparative advantage is relevant to the arguments for and against trade restrictions (as discussed in Chapters 20.1, 20.2, 20.3, 20.4, and 20.5).
  • The principle of comparative advantage is central to the debate surrounding trade policy and protectionism. Proponents of free trade argue that by specializing in goods with comparative advantage and engaging in international trade, countries can achieve higher levels of productivity and consumption, ultimately benefiting consumers. However, opponents of free trade may argue that comparative advantage can lead to job losses and wage stagnation in certain industries, justifying trade restrictions to protect domestic producers. Governments must balance the long-term benefits of comparative advantage with the short-term costs and tradeoffs when enacting trade policies.

Related terms

Absolute Advantage:

The ability to produce a good using fewer inputs than another producer, resulting in a lower cost of production.

Opportunity Cost:

The cost of an alternative that must be forgone in order to pursue a certain action or choice.

International Trade: The exchange of goods and services between countries, allowing for specialization and the exploitation of comparative advantages.