Absolute & Comparative Advantage

Test yourself on Absolute & Comparative Advantage

Test your knowledge with free interactive questions on Seneca — used by over 10 million students.

Comparative Advantage

Free trade can allow countries to specialize in the goods they are most efficient at producing. Trade means that they can buy some goods from other countries, rather than producing them themselves.

Opportunity cost of production

If a country produces sugar, it has an opportunity cost of production.
The labor and capital used to make sugar cannot be used to make wheat at the same time.
- E.g. if Brazil can produce a lot of sugar cane per acre but not much wheat, and the US can produce a lot of wheat but not sugar cane, then the US has a lower opportunity cost of producing wheat than Brazil.
This can be shown using production possibility frontiers (PPFs), which are also known as production possibility curves (PPCs).

Absolute advantage

A country has an absolute advantage in producing a good over another country if it uses fewer resources to produce that good (i.e. It can produce a good more efficiently than other countries).
Absolute advantage can be the result of a country’s natural endowment. For example, extracting oil in Saudi Arabia is pretty much just a matter of “drilling a hole.” Producing oil in other countries can require considerable exploration and costly technologies for drilling and extraction—if they have any oil at all.

Comparative advantage

A country has a comparative advantage in producing a good over another country if it has a lower opportunity cost of producing that good than other countries.
Countries tend to have different opportunity costs of producing a specific good, either because of different climates, geography, technology, or skills.
The disparity in comparative advantages between economies provides the basis for international trade.
Think of comparative advantage as what a country is least bad at - they all have to produce something!

Example of a Comparative Advantage

Comparative advantages between economies tend to be the result of different climates, geography, technology, or skills.

Comparative advantage in practice

Suppose the US and Brazil need to decide how much they will produce of two crops: sugar cane and wheat.
Due to its climatic conditions, Brazil can produce quite a bit of sugar cane per acre but not much wheat. Conversely, the U.S. can produce large amounts of wheat per acre, but not much sugar cane.
Clearly, Brazil has a lower opportunity cost of producing sugar cane (in terms of wheat) than the U.S. The reverse is also true: the U.S. has a lower opportunity cost of producing wheat than Brazil.

Comparative advantage in practice

This situation can be illustrated using two PPCs, as shown above.

Comparative advantage in practice

The U.S. PPC is flatter than the Brazil PPC implying that the opportunity cost of wheat in terms of sugar cane is lower in the U.S. than in Brazil.
Conversely, the opportunity cost of sugar cane is lower in Brazil. The U.S. has comparative advantage in wheat, and Brazil has comparative advantage in sugar cane.