Question

What is Comparative Advantage? Explain with an example of a two-country and two-commodity model.

Answer 1

Suppose, there are two countries A and B both producing two products X and Y. Let both countries have 100 units of labor each. Now, a single unit of labor in country A can produce 1 unit of product X or 2 units of product Y. Also, a single unit of labor in country B can produce 4 units of product X or 3 units of product Y.

Thus, with 100 labor, country A can produce either 100 units of product X or 200 units of product Y.

Similarly, with 100 labor, country B can produce either 400 units of product X or 300 units of product Y.

Now, opportunity cost of producing X in country A = number of units of product Y sacrificed to produce 1 unit of product X = 2/1 = 2

Similarly, opportunity cost of producing X in country B = number of units of product Y sacrificed to produce 1 unit of product X = 3/4 = 0.75

Thus, opportunity cost of producing X is lower for country B.

Now, opportunity cost of producing Y in country A = number of units of product X sacrificed to produce 1 unit of product Y = 1/2 = 0.5

Similarly, opportunity cost of producing Y in country B = number of units of product X sacrificed to produce 1 unit of product Y = 4/3 = 1.33

Thus, opportunity cost of producing Y is lower for country A.

Now, from the definition of comparative advantage, a country is said to have comparative advantage in the production of a good in which it enjoys relatively lower opportunity cost . Thus, comparative advantage is the advantage enjoyed by a country in which production of a good is relatively cheaper.  

Thus, in the above example , country A has comparative advantage in the production of product Y and country B has comparative advantage in the production of product X.