Comparative advantage is the ability to produce a good or service at a lower opportunity cost than another person or group. Every person, business, or country starts out with a finite number of available resources, so there are always trade-offs involved in deciding which goods to produce. These trade-offs can be thought of as opportunity costs. An opportunity cost is the value or benefit of the next best alternative given up when making a choice. If a farmer has the chance to produce apples or cherries but can only produce one of those per season, each time they choose to produce cherries, for example, they forgo the chance to produce apples. Thus, the opportunity cost of producing cherries is the amount of apples that are not produced.
The country or person that has a lower opportunity cost for each unit of output has a comparative advantage. For example, say Costa Rica and Panama produce different kinds of fruit. Both Costa Rica and Panama produce apples and cherries. Each time Panama chooses to produce apples to compete with Costa Rica, it gives up the opportunity to produce more cherries and may face a high opportunity cost compared to Costa Rica, which may not give up as much to produce apples. Costa Rica has the comparative advantage in this case.
Comparative advantage can also be thought of when considering smaller-scale manufacturers or individuals. Alice and Becca build clocks and doorframes. It takes Alice 12 hours to build a clock and 6 hours to build a doorframe. During those 12 hours, she could have completed 2 doorframes, or Alice could build 1 doorframe when she could have been building 1/2 of a clock. It takes Becca 8 hours to build a clock and 2 hours to build a doorframe. In 8 hours, Becca could have built 4 doorframes. Meanwhile, 1 doorframe for Becca has an opportunity cost of 1/4 clocks. Becca has an absolute advantage because she can complete both doorframes and clocks the fastest; Alice has a comparative advantage in building clocks (she only gives up the opportunity to produce 2 doorframes, while Becca gives up producing 4). Becca has a comparative advantage in building doorframes (she only gives up the opportunity to build 1/4 clocks, while Alice gives up producing 1/2). It makes sense for each of them to produce the good for which they have a comparative advantage because then each person would have a lower opportunity cost in their respective good and they can increase their combined outputs through trade.
Comparative Advantage and Decision Making in Production
|Opportunity Cost (to produce 1 unit)|
|Alice||2 doorframes||1/2 clocks|
|Becca||4 doorframes||1/4 clocks|