The Comparative

Advantage Theory of
Competition
By Manisha Sadani
What Is Comparative Advantage?
Comparative advantage is an economy's ability to produce a particular good or
service at a lower opportunity cost than its trading partners. A comparative
advantage gives a company the ability to sell goods and services at a lower price
than its competitors and realize stronger sales margins.

The law of comparative advantage is popularly attributed to English political

economist David Ricardo and his book “On the Principles of Political Economy
and Taxation” written in 1817, although it is likely that Ricardo's mentor, James
Mill, originated the analysis.
Understanding Comparative Advantage :-

Comparative advantage is one of the most important concepts in economic

theory and a fundamental tenet of the argument that all actors, at all times,
can mutually benefit from cooperation and voluntary trade. It is also a
foundational principle in the theory of international trade.

The key to understanding comparative advantage is a solid grasp of

opportunity cost. Put simply, an opportunity cost is a potential benefit that
someone loses out on when selecting a particular option over another.
In the case of comparative advantage, the opportunity cost (that is to
say, the potential benefit which has been forfeited) for one company is
lower than that of another. The company with the lower opportunity
cost, and thus the smallest potential benefit which was lost, holds this
type of advantage.

Another way to think of comparative advantage is as the best option

given a trade-off. If you're comparing two different options, each of
which has a trade-off (some benefits as well as some disadvantages), the
one with the best overall package is the one with the comparative
advantage.
How It Affects You ?

Comparative advantage is what you do best while also giving up the least. For
example, if you’re a great plumber and a great babysitter, your comparative
advantage is plumbing. That's because you’ll make more money as a plumber.
You can hire an hour of babysitting services for less than you would make
doing an hour of plumbing. Your opportunity cost of babysitting is high.
Every hour you spend babysitting is an hour’s worth of lost revenue you
could have gotten on a plumbing job.
Comparative Advantage vs. Absolute Advantage :-
Absolute advantage is anything a country does more efficiently than other
countries. Nations that are blessed with an abundance of farmland, fresh
water, and oil reserves have an absolute advantage in agriculture, gasoline,
and petrochemicals.1

Just because a country has an absolute advantage in an industry doesn't mean

that it will be its comparative advantage. That depends on what the trading
opportunity costs are. Say its neighbor has no oil but lots of farmland and
fresh water. The neighbor is willing to trade a lot of food in exchange for oil.
Now the first country has a comparative advantage in oil. It can get more food
from its neighbor by trading it for oil than it could produce on its own.
Comparative Advantage vs. Competitive Advantage :-
Competitive advantage is what a
country, business, or individual
does that provide a better value
to consumers than its
competitors. There are three
strategies companies use to gain
a competitive advantage. First,
they could be the low-cost
provider. Second, they could
offer a better product or service.
Third, they could focus on one
type of customer.
The Bottom Line :-
Individuals, corporations, and nations engage in commerce to capitalize on their
advantages. These advantages could be absolute, competitive, or comparative in nature.
Nations mostly base their decisions on what to import or export on the concept of
comparative advantage. This states:

● A country may have an absolute or competitive advantage over another. But, it

often chooses to specialize production on a good or service which it can make
most efficiently, relative to its trading partners.
● A nation with comparative advantage channels its capital, labor, and natural
resources on production requiring lower opportunity costs and higher profit
margins.
Conclusion :-
Thus, Comparative advantage is a key principle in international
trade and forms the basis of why free trade is beneficial to
countries. The theory of comparative advantage shows that even
if a country enjoys an absolute advantage in the production of
goods, trade can still be beneficial to both trading partners.
THANK YOU