Glossary · Economic ideas
Comparative advantage
Comparative advantage means doing what you give up the least to do. When each side specializes that way and trades, both can end up with more.
Also called: law of comparative advantage, Ricardo’s theory of trade, gains from trade, absolute advantage
In plain words
A top lawyer may type faster than her assistant. Should she do her own typing? No: every hour she types is an hour of legal work she gives up, worth far more. The assistant gives up much less to type. Each doing what costs them least is comparative advantage.
The surprising part: it works even when one side is better at everything. What matters is not who is best at a task, but who gives up the least to do it, their opportunity cost.
Countries trade for the same reason. By making what they are relatively best at and swapping, two countries can both end up with more of everything than if each made everything for itself.
Example
Wine and cloth, after David Ricardo
In 1817 the economist David Ricardo used wine and cloth from Portugal and England to show why trade pays. Here are simpler numbers in the same spirit. Each country has 10 workers.
- In Portugal a worker makes 4 bottles of wine or 2 rolls of cloth a day; in England, 1 bottle or 1 roll. Portugal is better at both.
- Without trade, each country puts 5 workers on each good: Portugal makes 20 wine and 10 cloth, England 5 wine and 5 cloth. Together: 25 wine, 15 cloth.
- Compare what each gives up. In Portugal a roll of cloth costs 2 bottles of wine not made; in England, only 1. So England has the comparative advantage in cloth, and Portugal in wine.
- Now England puts all 10 workers on cloth (10 rolls), and Portugal puts 7 on wine (28 bottles) and 3 on cloth (6 rolls). Together: 28 wine, 16 cloth.
Same workers, more of both goods. If England swaps 4 rolls of cloth for 6 bottles of wine, it ends with 6 wine and 6 cloth (up from 5 and 5), and Portugal with 22 wine and 10 cloth (up from 20 and 10).
One level deeper
The idea is David Ricardo’s, from On the Principles of Political Economy and Taxation (1817). It is one of the few results in economics that is both true and far from obvious: when the mathematician Stanislaw Ulam challenged Paul Samuelson to name such a result, Samuelson picked this one.
Absolute advantage means making something with fewer resources; comparative advantage means making it at a lower opportunity cost. A country can have the absolute advantage in everything, but never the comparative advantage in everything.
The theory says trade makes countries better off as a whole. It does not say everyone gains: workers in industries that shrink can lose, which is why trade, and tariffs, are debated so hotly.
Why it matters
It is the main reason countries trade, and why most of what you own was made in many places.
It explains specialization in daily life: people do one job well and buy the rest, instead of making their own clothes, food and phones.
It shows why “they are better at everything, so we can’t compete” is a mistake: what matters is relative cost, not absolute skill.
A common mistake
Myth: If another country can make everything more cheaply, trading with it can only hurt us.
In fact: Even then both sides can gain, as the wine-and-cloth example shows: each specializes where its opportunity cost is lowest. The gains are real, though they are not shared equally inside each country.
Questions people ask
What is the difference between absolute and comparative advantage?
Absolute advantage: you can make more of something with the same resources. Comparative advantage: you give up less of other things to make it. Trade follows comparative advantage.
Who came up with comparative advantage?
David Ricardo set it out in 1817, though Robert Torrens had sketched it a little earlier. Ricardo’s example was English cloth and Portuguese wine.
Does comparative advantage apply to people?
Yes. It is why a doctor hires someone to do the paperwork even if she could do it faster herself: her hour is worth more seeing patients.
Read more on BigCapital
About the numbers
- This page explains a term. It is not investment advice.