Comparative Advantage

Comparative Advantage, the idea that economic agents, such as workers and organizations, are best used in the activities that they are best at. In general, this is taken to mean that if X is better than Y at bricklaying and Y is better than X at carpentry, then it makes sense for X to work at bricklaying and Y to work at carpentry. However, the theory of comparative advantage also suggests that if an economic agent is worse than anyone else at a particular task, it still makes sense to work at that task if the agent is even worse at doing other things. This apparently obvious theory in fact has important ramifications.

It is in the area of international trade that the idea of comparative advantage has been considered to have most importance, arguing that the world will be better off if each country concentrates on producing what it is best at producing, even if other countries are better at producing it. This is an important factor in theories of global economic competition, industrialization, and development economics. What each country produces will, of course, depend on the raw materials it has available to it and the skills of its people, and these will change over time. Another part of the theory of international trade, developed by David Ricardo in the early 19th century, is the law of comparative costs, which outlines the conditions where two countries will trade two types of goods, even though both may be produced more cheaply in one country than the other.

Modern terminology in economics tends to refer less to comparative advantage and more to competitive advantage. Factors identified as important when considering the competitive advantage or disadvantage of a company include the existing rivalry between firms in the same business; the threat of new companies entering that line of business; the threat of other products or services replacing the ones currently being provided; and the bargaining power of both buyers and suppliers. Similar factors can account for some countries being more competitive in certain business sectors than other countries. Modern theories of comparative advantage in the world economy go along with principles of free trade: emphasis on the value of free competition, and pursuit of the goal of the open economy.