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Comparative Advantage Definition

Comparative Advantage Definition

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Comparative Advantage Definition

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Microeconomics: Comparative Advantage

The law of comparative advantage was first mentioned in 1817 by English economist David Ricardo.

A company has a comparative advantage when it is able to provide a good or service at a lower opportunity cost than others, helping it sell the same product at a lower cost, resulting in better margins.

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An opportunity cost is the potential ‘alternative’ or benefit that is forfeited when one chooses a particular option.

The other, foregone option, if it is lower than other companies, is the key factor in this trade-off.

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Comparative advantage is also measured by the salary yardstick, and how much a person’s time, skills and core skill sets are worth.

Example: Michael Jordan is a skilled basketball player, and is very tall. If he wants, he could paint his own house by himself and do it quickly due to his height. But as he is also a skilled sportsperson, he could earn much more in that time, and probably hire someone else to paint his house, even if the hired painter (who has a comparative advantage due to his specialization of painting houses) takes more time to do it.

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  • Comparative advantage is only an advantage of a lower opportunity cost, and does not factor in volume or quality.
  • Absolute advantage is the pure ability of a company to produce better goods or services (in quantity or quality) than the competition.

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When a company is at a better position to provide strong value to the customer, it is said to be at a competitive advantage.

Example: A cable TV operator offers low cost wifi internet services at great speeds and no downtime, which isn’t offered by the competition in that area. The decades of experience in cable TV makes for a competitive advantage.

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Certain countries have unique strengths, local resources and talent that can be a comparative advantage to them, and make products at a cheaper cost than other countries. If they indulge in protectionism, the end result is higher costs and inefficiency for all.

Example: China has a low opportunity cost to produce simple consumer goods due to the cheap labour it employs, and countries like France and America do not need to focus on simple goods, so are able to make sophisticated products like rockets, cars and ships.

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Governments around the world impose rules, regulations and restrictions like:

  1. Tariffs
  2. Selective trade agreements.
  3. Lobbying and rent-seeking to protect a country's interests.
  4. Tax breaks and special deals
  5. Sanctions

These practices ensure that comparative advantage does not benefit all like it should, and stifles equality and growth of small players.

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