Course Hero Logo

Comparative Advantage and Trade

Relationship between Comparative Advantage and Free Trade

Countries can benefit from comparative advantage when making free trade agreements.

Having a comparative advantage means a country, individual, or business is producing a good or service the most cheaply, compared to others. Comparative advantage is one of the main reasons countries trade. One country may excel at coffee production, while another has a comparative advantage in producing cheese. These two countries can increase trade output by focusing their trade efforts on their respective industries with a comparative advantage.

Comparative advantage forms the basis for a free trade agreement (a bargain made between countries to foster trade, such as lowering tariffs), which presumes that countries do best and grow their economies by nurturing the industries in which they have the greatest comparative advantage. For example, if Alice is better at building clocks than doorframes and Becca is better at building doorframes than clocks, they will focus their production efforts on the product at which they excel. Eventually, Alice will stop making doorframes and Becca will stop making clocks, and both will save money in the process and improve their bank accounts (i.e., their economies). They both get more value from only producing what is most efficient for them and trading with each other for the other good.