4.1 Comparative Advantage
Comparative advantage looks specifically at a countries opportunity cost of producing a good. If a country has a lower opportunity cost of producing a good then it means that is has to give up less of other goods in order to produce this goods; this means that a country has a comparative advantage in producing that good. Let’s suppose that we have two countries below. We have the UK and Portugal and they produce two goods; wine and cheese. Below we have a table showing the output combinations of the two countries when they use half of their resources in the production of each good.
The opportunity cost of 1 unit of cheese for the UK is 2 units of wine. The opportunity cost of 1 unit of cheese for Portugal is 3. Therefore, the UK has a comparative advantage in producing cheese as they have a lower opportunity cost. As well as the working out the opportunity cost of cheese production we can also work out the opportunity cost for wine production. The opportunity cost for the UK for producing 1 unit of wine is 0.5 of cheese. For Portugal the opportunity cost is 1/3. As Portugal has a lower opportunity cost, Portugal has a comparative advantage in producing wine.
If these countries specialized is what they had the comparative advantage in, the combined output for these two countries would increases. Let’s suppose that the UK specializes in cheese and Portugal specializes in wine. If this happens we get the output for the table below.
If these countries specialized is what they had the comparative advantage in, the combined output for these two countries would increases. Let’s suppose that the UK specializes in cheese and Portugal specializes in wine. If this happens we get the output for the table below.
Before when our countries devoted half of their resources to producing each of the goods, the total output was 4 units of cheese and 10 units of wine. Now our countries specialize, our total output is 4 units of cheese and 12 units of wine. Our total output of cheese for the two countries has remained the same but for wine total output has increases. Therefore, economies are better off when specialization occurs with countries specializing in what they have comparative advantage in. If the numbers were different in the example, total output would have been greater for both goods.