Comparative Advantage: the Basis for Trade
Specialisation is where everyone in the economy concentrates on producing goods or services at which they perform the best at relative to others. They then satisfy their needs for other goods and services by trading among themselves.
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Absolute Advantage |
Comparative Advantage |
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When one person is able to produce a good or service, or perform a certain task, with less resources than another person |
When one person’s opportunity cost of producing a good or service, or performing a certain task, is lower than another’s. |
The principle of comparative advantage:
Everyone can do better when each person concentrates on the activities for which their opportunity cost is lowest, i.e. for which they have a comparative advantage. By specialising, the total output is greater due to the difference in opportunity costs.
Comparative Advantage can also be illustrated on a production possibility curve, a graph comparing the production rate of two good/services. Features of this curve are:
- Attainable point: any combination of goods that can be produced using available resources, i.e. all points on or under the curve
- Unattainable point: any combination of goods that cannot be produced using available resources, i.e. all points on right and outside of the curve
- Efficiency point: maximum amount of any goods that can be made with available resources, i.e. any point on the curve
- Inefficiency point: any amount of goods for which available resources can increase the production of one good without any reduction in the other,i. e. points on the left of the curve
- Gradient: the slope at any point indicates the opportunity cost of the action
Principle of increasing opportunity cost (low-hanging fruit principle)
In the expansion of the production of any good, first employ those resources with the lowest opportunity cost, and only turn to those with higher opportunity cost after
