What Is Comparative Advantage?
Define Comparative Advantage in Simple Terms
Comparative advantage is a country or company’s ability to produce goods and services at a lower opportunity cost than other countries or companies. An opportunity cost is a potential economic benefit that a country or firm loses out on when producing one good or service over another. By producing goods with the lowest opportunity cost, countries realize the greatest economic benefits; therefore, comparative advantage allows a company to sell goods and services at a lower price and realize stronger sales margins than its competitors.
Comparative Advantage Example
For example, Country A and Country B produce both avocados and bell peppers. Let’s say Country A produces 200 avocados and 100 bell peppers per year. Country B produces 300 bell peppers and only 100 avocados. Country A has the ability to produce more avocados at a lower opportunity cost, due to the fact that Country A receives more sunlight which avocados need to grow. This gives Country A the comparative advantage in producing avocados. Country B is less sunny on the other hand and is able to grow more bell peppers. Therefore it has a comparative advantage in producing bell peppers. Theoretically, if both countries produced the goods in which they have the comparative advantage, both more avocados and bell peppers would be produced and both economies would benefit.
Comparative Advantage vs Absolute Advantage
Absolute advantage, though similar to comparative advantage, refers to the ability to produce more or better goods and services than their competitor, not necessarily at a lower opportunity cost. Comparative advantage incorporates opportunity cost in the analysis when choosing between options for optimum production.
Comparative Advantage Definition FAQs
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.