What is comparative advantage, and why does it matter?

Comparative advantage is an economic principle that explains why people, firms and countries can often benefit from trade even when one party is more productive at making every good or service. A party has it when it can produce something at a lower opportunity cost than its trading partners. Opportunity cost is the value of what is given up in order to make that thing. [1] [2] [3]

Absolute advantage means being the best at something, or being able to produce more of a good. Comparative advantage is about cost measured in other goods given up. Econlib's example is Michael Jordan, who might also be the fastest typist in the world. If he spent time typing, he would give up the large income he earns from basketball, so his secretary is the lower-cost typist and holds the comparative advantage at typing. [3]

The Wikipedia entry also separates both ideas from competitive advantage, which concerns outperforming rivals in a marketplace. The World Trade Organization calls comparative advantage one of the most misunderstood ideas in economics, often wrongly assumed to mean an absolute advantage over other countries. [1] [4]

OpenStax gives a simple illustration with oil and corn. In its table, Saudi Arabia gives up one quarter of a bushel of corn to produce a barrel of oil, while the United States gives up two bushels. Saudi Arabia therefore has the comparative advantage in oil. The United States gives up only half a barrel of oil per bushel of corn, against four barrels for Saudi Arabia, so it has the comparative advantage in corn. [5]

If each country specializes and they trade at a rate that suits both, each can end up consuming more of both goods than before. OpenStax says total global output increases when each country specializes in its comparative advantage. [5]

The idea is usually credited to David Ricardo, whose 1817 treatise On the Principles of Political Economy and Taxation argued that specialization and free trade benefit all trading partners, even relatively inefficient ones. His standard examples involved wine and cloth. The WTO notes that a country need not be best at anything to gain from trade. It gains by specializing in what it is relatively better at, at world prices. [5] [6] [4]

Because the advantage is relative, the WTO says it is meaningless to claim a country has a comparative advantage in nothing. Econlib makes the same point for individuals: everyone has a comparative advantage at something, so to find it one should compare opportunity costs, not absolute skills. [4] [3]