Comparative Advantage Examples

Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Comparative Advantage Examples

The following Comparative Advantage example outlines the most common comparative advantages. It is impossible to provide a complete set of examples that address every variation in every situation since there are hundreds of such comparative advantages. Each example of the comparative advantage states the topic, the relevant reasons, and additional comments as needed.

The economic principle of comparative advantage holds in the case of free trade. The countries specialize in producing goods and services that they can produce more efficiently with lower opportunity costs than the other goods and services. It results from different endowments of the various factors of production, i.e., labor, capital, land, entrepreneurial skill, technologies, etc. Therefore, a country should export those goods and services with a relative advantage over the other country. The relative productivity is higher, and import where the opportunity costOpportunity CostThe difference between the chosen plan of action and the next best plan is known as the opportunity cost. It's essentially the cost of the next best alternative that has been forgiven.read more is higher. It ensures utilizing the benefits of the existing free international trade.

Key Takeaways

  • The comparative advantage example displays the most common comparative advantages. As numerous comparative advantages exist, offering models that convey each variation in every situation is impractical.
  • Cost, labor, production efficiency, and agriculture & industry are examples of comparative advantage in the real world.
  • Determining the right balance between the import and export of the two countries in the global marketplace is crucial. Moreover, it helps to realize more substantial margins in the long run for every trading economy
Comparative Advantage Examples

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Examples of Comparative Advantage in Real World

The following are examples of comparative advantage in the real world

Example #1 – Cost

Country A can manufacture cotton @ $2 and silk @$20.

Country A can sell cotton to other nations at $3 and import silk from other nations at $18. Therefore, country A would benefit by exporting content and importing silk instead of producing silk at a higher cost.

Comparative Advantage Example 1

Example #2 – Labor

Two countries – Country A and Country B – can produce two commodities with labor-intensiveLabor-intensiveLabor intensive implies those tasks which require a heavy workforce for accomplishment. In the production of goods and services, the industry is considered labour intensive if the manufacturing process relies more on human resource than machinery.read more input – Widget A and Widget B. In Country B, one worker’s labor can produce ten Widget A or 12 Widget B pieces. One hour of the workers’ labor produces either 20 pieces of Widget A or 15 Widget B in the US. The same is illustrated in the below table:

Comparative Advantage Example

To decide which country has a comparative advantage over which commodity than the other country, the opportunity cost needs to be determined first.

Country B

  • Opportunity Cost of 1 Widget A is 1.2 Widget B
  • Opportunity Cost of 1 Widget B is 0.8 Widget A

Country A

  • Opportunity Cost of 1 Widget A is 0.75 Widget B
  • Opportunity Cost of 1 Widget B is 1.3 Widget A

On comparing the opportunity cost for both the countries for one product at a time, we can derive the below conclusion :

  • The opportunity cost for 1 Widget A for Country B is 1.2 Widget B. For Country A, it is 0.75 Widget B. Therefore, the Opportunity cost for Country A is lesser for Widget A; hence, it has a comparative advantage over Country B for cloth.
  • The opportunity cost for 1 Widget B for Country B is 0.8 Widget A, and for Country A, it is 1.3 Widget A. It means that the opportunity cost for Country B for Widget B is lesser than Country A. Therefore, Country B enjoys a comparative advantage for Widget B over Country A.

Example #3 – Production Efficiency

Consider the production efficiency for the two countries – India and the UK –. have, let us assume, 100 units of each production factor. These 100 units need to be employed to produce either rice or tea.

Now, in the production of 1 ton of tea – India requires only five resources while the UK requires ten resources. Also, in rice production for 1 ton – India requires ten resources, whereas the UK requires only 4. It explains that India is relatively more efficient than the UK in producing a team, while the UK is more efficient in producing rice compared to India. The same can be illustrated below:

 Example 3

It suggests that if the UK wants to produce 1 ton of tea, it has to forgo the production of 2.5 tonnes of rice. However, to produce 1 unit of rice, it has to forgo the production of only 0.40 tonnes of tea.

Specialization – If both the countries- India and the UK, employ all their resources in the production of both commodities – rice and tea, respectively, in which each of the countries has a comparative advantage over the other- the total output of tea would increase from 15 to 20 tonnes. Output for rice would increase to 20 tonnes. Therefore, if the countries merge their specialization, they can gain from the trade and enhance the total output levels.

Example #4 – Agriculture & Industrial

Suppose a country is agriculture-based compared to another industrial goods-based, for example, Peru and China. Peru is an agricultural country, and let us say it produces ropes. It should be exporting this product to its trade partner China by importing goods and services like electrical equipment – which Peru does not have the option to produce from scratch. Based on this theory of comparative advantage, Peru and China both remain at an economic gain in the free trade marketplace.

Video on Absolute Advantage vs Comparative Advantage

 

Conclusion

Even in the case of Absolute advantageAbsolute AdvantageAbsolute Advantage focuses on producing better quality & an increased number of goods & services for an entity to gain more profits than its competitors. In contrast, Comparative Advantage focuses on the Company’s capability of manufacturing goods & services at a relatively lower opportunity cost than others. read more that an economy might have, in the case of Absolute advantageAbsolute AdvantageAbsolute Advantage focuses on producing better quality & an increased number of goods & services for an entity to gain more profits than its competitors. In contrast, Comparative Advantage focuses on the Company’s capability of manufacturing goods & services at a relatively lower opportunity cost than others. read more – where free trades exist – comparative advantage becomes very important in finding the right balance between the import and export between the two countries in this global marketplace. The reasons could vary from the diversity of skills, lack of environmental support, costs, but the basis of this economic term remains the ability of an economy to produce any goods or services at lower opportunity costs compared to its trade partners. It helps to realize stronger margins in the long run for each trading economy

Frequently Asked Questions (FAQs)

Why is comparative advantage significant in international trade?

In international trade, comparative advantage law is usually used to explain globalization. Countries may have higher material outcomes by producing only goods with a comparative advantage and trading those goods with other countries.

How does comparative advantage compare to absolute advantage?

Comparative advantage is not similar to absolute advantage. Absolute advantage means the capability to create more or better goods and services than others. In comparison, comparative advantage means the capacity to generate goods and services at a lesser opportunity cost, irrelevant to a greater volume or quality.

Why is comparative advantage significant for trade?

Comparative advantage allows companies to sell goods and services at lesser prices than their competitors, earning more substantial sales margins and high profitability.

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