Comparative Advantage Versus Absolute Advantage
Comparative Advantage Versus Absolute Advantage

As you can see from the example above, a country can have a comparative advantage in producing a good even if it is absolutely less efficient at producing that good. To understand this more clearly, think of an example of a doctor in private practice:

A young doctor opens her own practice, working by herself, and within a few months has developed a substantial clientele. At first, she was performing all her clerical work—filing, typing and answering the phone—by herself. With an ever-busier schedule, however, she realizes that she could spend more time seeing patients, and thus see a greater number of patients, if she hired an assistant.

As it turns out, the young professional is not only a brilliant doctor, but is also lightning-fast at typing and filing. She is, in fact, better at doing both jobs than the clerical assistant she hires. In other words, she has an absolute advantage at both tasks: medical diagnosis and clerical work.

Does it make sense then for the doctor and her assistant to share both tasks, each spending part of the day diagnosing patients and doing clerical work? The answer is no. By having the assistant perform all the clerical work, the doctor is able to maximize her specialization and see more patients. The patients are undoubtedly better off too.

In other words, even though the assistant is worse at performing both tasks, an economist would say that he nonetheless has a comparative advantage at clerical work. As you can see, by working together – trading their services – the doctor and the assistant are able to maximize their skills, making both better off.

As these examples show, trade allows countries to specialize in the production of what they do best and make the most efficient use of their resources, thereby decreasing the price of both goods. No matter how inefficiently a country produces every kind of good, it can always be said to have a comparative advantage in at least one of those goods.

That is the theory of comparative and absolute advantage. It helps explain what happens in the real world of international trade, and it offers broad guidance to countries as they decide which goods and services to produce and subsequently export, and which, in turn, to import.

Trade in Theory and Practice

In reality, of course, trade specialization does not work precisely the way the theory of comparative advantage might suggest, for a number of reasons:

  • No country specializes exclusively in the production and export of a single product or service.
  • All countries produce at least some goods and services that other countries can produce more efficiently.
  • A lower income country might, in theory, be able to produce a particular product more efficiently than the United States can but still not be able to identify American buyers or transport the item cheaply to the United States. As a result, U.S. firms continue to manufacture the product.

Generally, countries with a relative abundance of low-skilled labor will tend to specialize in the production and export of items for which low-skilled labor is the predominant cost component. Countries with a relative abundance of capital will tend to specialize in the production and export of items for which capital is the predominant component of cost.

Many American citizens do not fully support specialization and trade.  They contend that imports inevitably replace domestically produced goods and services, thereby threatening the jobs of those involved in their production.

Imports can indeed undermine the employment of domestic workers. We will return to this subject a little later. From what you have just read, you can see that imports supply products that are either 1) unavailable in the domestic economy or 2) that domestic enterprises and workers would be better off not making so that they can focus on specialization of another good or service. .

Finally, international trade brings several other benefits to the average consumer. Competition from imports can enhance the efficiency and quality of domestically produced goods and services. In addition, competition from imports has historically tended to restrain increases in domestic prices.

Discussion Questions:

  • Name a product/business where labor would be the comparative advantage for a poor country.
  • Name a product/business where capital would be the comparative advantage for a rich country.
  • Name a product/business where natural resources would be the comparative advantage.

 

Next: The Trade Balance