Question

what is Comparative Advantage?

what is absolute advantage?

what would you rather have a comparative or absolute advantage with trading?

Answer 1

Comparative advantage refers to the idea that one country has a relative advantage in terms of producing a good with regards to another. This basically means that the country has a lower marginal cost of producing a good/service compared to the other country.

Absolute advantage refers to the idea that a country typically uses lower resources in producing the good in question. In other words, it is technologically superior than the other in production.

The doctrine of comparitive advantage was given by Ricardo while the idea of absolute advantage was given by Smith.

Smith was of the idea that trade cannot take place between a country which is backward and another which is technologically superior to it (or has absolute advantage). But Ricardo claimed that comparitive advantage is in fact the driver of trade between nations.

Ricardo claimed that a country in spite of having absolute advantage in all lines of production, can have comparitive advantage in a few goods.

Comparitive advantage creates price difference between countries. Relative price differences across nations create scope for arbitrage (i.e. buying cheap from a country where prices are low and selling it dear to another country where prices are high and making a profit thereof). Arbitrage is the basis of trade.

The idea of Ricardo was the following :

By the doctine of comparitive advantage, trade can take place between a technologically advanced country like the USA and technologically backward country like Bangladesh. In this scenario, it will have comparitive advantage in production where it has the highest technological superiority and comparive disadvantage in those production in which it's superiority is the least. That's the reason why Bangladesh is in a position to produce cotton textiles at much cheaper cost than the United States while the latter can produce computers by a similar logic.

Ricardo explained his stance by the famous example :

A lawyer can defend his client in a court of law and do the related secretarial work better than his secretary. But as he is more superior when it comes to the legal practices, he can devote all the time for preparing himself and defend his client. He would rather appoint a secretary to do the associated job of typing and providing him assistance.