Introduction
Comparative advantage refers to an economic theory that depicts the ability of an individual or a firm to produce services or goods at a lower opportunity cost in comparison to other competitors in the same industry. Firms that have the comparative advantage over others are associated with lower marginal costs before the commencement of trading. The aspect of comparative advantage enables manufacturers to sell their product at a lower cost in comparison with their rivals in the market thus resulting in higher profit margins due to increased sales. When establishing the comparative advantage, the monetary and resource costs are not compared. On the contrary, the opportunity costs of services and products across various agents are related (Suri, 2011). This section highlights the concept of comparative advantage, its distinction with absolute advantage, and its role in international trade.
David Ricardo advanced the classical theory of comparative advantage. The theory sought to explain why different countries collaborate in international trade albeit workers in a specific nation are more efficient in producing each unit of a good or service as compared to those in other nations. According to Ricardo, in instances where two countries embark on producing two different commodities in a free market, each of the countries will opt to export the commodity for which it bears comparative advantage while importing the other commodity thus increasing its total consumption rates (Cuñat & Melitz, 2012). For this scenario to play out, the two countries should have differences in their labor productivity. Additionally, comparative advantage dominates more international trade deals as compared to absolute advantage.
Comparative advantage vs. absolute advantage
These two terms are used when dealing with international trade; however, they have distinguishing characteristics. Absolute advantage is the capability of a given nation to produce specific goods and services at relatively lower costs when compared to other nations. Absolute advantage results in increased productivity using fewer resources regarding labor as compared to other countries that also produce similar products or services. On the other hand, a country gains the comparative advantage over another through producing services or goods that have a lower opportunity cost as compared to anything else that the country could have done with its resources (Schumacher, 2012). Therefore, the cost factor is affiliated to absolute advantage whereas the opportunity cost factor is associated with comparative advantage.
Absolute advantage breeds more efficiency in the production of goods and delivery of services due to its relatively lower marginal costs of producing an extra unit of a product or service. The lower marginal costs emanate from the availability of cheap labor or material inputs thereby resulting in higher productivity. On the other side, comparative advantage focuses on relating the production outputs of a similar type of goods or services between two nations thus establishing which nation is better than the other (Schumacher, 2012).
Countries with absolute advantage are often associated with the specialization in their production processes by devoting their resources to the production of few selected products or services. For instance, due to the specialization of the United States in the manufacture of technological products, other nations import such products from the US because it bears absolute advantage (Suri, 2011). However, countries with comparative advantage specialize in the production services and goods that attract relatively lower opportunity costs as compared to other nations.
Unlike absolute advantage that is entirely concerned with multiple goods, comparative advantage encompasses the manufacture of goods and the production of services within a stipulated period (Krugman & Obstfeld, 2009). Additionally, trade is not mutually beneficial under the confines of absolute advantage while it is mutually beneficial in the comparative advantage case.
Comparative advantage in international trade
The concept of comparative trade is one of the most important theories in international trade. A county’s infrastructure, the level of technology, and labor force are some of the contributing factors that make a nation have a comparative advantage over another (Cuñat & Melitz, 2012). The discovery of comparative advantage amounted to material development in economics and international trade.
The comparative advantage when intertwined with specialization results in a powerful incentive by creating a wide platform for different nations to exchange varying goods and services. When citizens and firms of a given nation concentrate their energies and resources to the production of certain services and goods, they must give up others to attain a competitive edge in the market, thus gaining a comparative advantage (Krugman & Obstfeld, 2009). Due to the differences originating from various nations around the globe regarding natural resource endowment, the level of technology, and innovation among other variances, the cost of producing similar goods differs, thus making it mandatory for the diverse nations to engage in foreign trade.
Comparative advantage is important in the international trade arena because it dictates to any given nation what to import or export. Most countries focus on creating goods and services that bear comparative advantage, and thus they export their products to other nations where the production costs of such similar items are high. Consequently, countries tend to import services and goods that give a comparative disadvantage to them (Suri, 2011). These varying interrelations require the international trade to act as the vessel through which various countries can exchange products and services.
Furthermore, comparative advantage helps when relating the productiveness across different industries and countries that engage in free trade. Any nation should export and trade goods that bear the highest productivity advantage and import those that pose a higher productivity disadvantage (Krugman & Obstfeld, 2009). The concept of international trade is thus irrelevant when the theory of comparative advantage is excluded because it takes preeminence when defining foreign trade.
References
Cuñat, A., & Melitz, M. J. (2012). Volatility, labor market flexibility, and the pattern of comparative advantage. Journal of the European Economic Association, 10(2), 225-254.
Krugman, R., & Obstfeld, M. (2009). International economics: theory and policy. Boston, MA: Pearson Addison-Wesley.
Schumacher, R. (2012). Adam Smith’s theory of absolute advantage and the use of doxography in the history of economics. Erasmus Journal for Philosophy and Economics, 15(2), 54-80.
Suri, T. (2011). Selection and comparative advantage in technology adoption. Econometrica, 79(1), 159-209.