Principal of Comparative Advantage

A country has a comparative advantage in the production of those goods which (compared to other goods and countries in the world) it produces more efficiently than other goods.

A country has absolute advantage if it is able to produce a good more efficiently than all other countries. Countries are able to gain from trade if they specialise in the production of goods which have a lower opportunity cost.

Determinants of Comparative Advantage

Comparative advantage results from differences in the costs of production

The following factors influence costs of production:

• Quantity and Quality of Factors of Production
• Available Research and Development
• Investment Changes in exchange rates (accounting for inflation)
• Import controls
• The degree of non-price competition between producers

Importance Of Comparative Advantage

• Comparative advantage emphasises the differences in relative productivity between countries
• Comparative advantage allows a country to make decisions about the best use of resources
• Comparative advantage allowed many developing countries to identify markets for their products

Limitations of Comparative Advantage

Economic models of comparative advantage only use a small number of products and countries – in reality the situation is more complex making comparative advantage harder to work out

Doesn’t consider the impact of transport costs – in reality these may make comparative advantage void

Many countries want to protect new industries and strategic industries and keep a more diverse industrial structure than suggested by comparative advantage