Comparative Advantage Calculator
Our comparative advantage calculator allows you to easily calculate the cost of opportunity to produce a certain good in a particular country. This metric will help you to understand the benefits of international trading and the manufacturing specialization of a country.
In this article, we will explain what is comparative advantage by exploring the comparative advantage theory and therefore how to calculate the comparative advantage. After explaining the comparative advantage definition, we will also demonstrate some comparative advantage examples to help you better understand this concept. If this interests you, keep reading!
What is comparative advantage?
Before we dive into understanding the concept of comparative advantage, it is essential to first understand what an absolute advantage is and the difference between them.
When the cost of producing a certain good is lower in a country than in other countries, the country has an absolute advantage over them. For example, if Country X's cost to produce a bottle of wine is 10 units of labor and Country Y's cost is 12 units of labor. Then, Country X is said to have an absolute advantage over Country Y.
The comparative advantage theory was developed by David Ricardo in 1817. A country has a comparative advantage over another country when the opportunity cost of producing a certain good is lower than in another country. It might not sound very clear for now, but the comparative advantage definition will become cleaerr when we demonstrate an example in the section below.
What is the comparative advantage in economics, and how to calculate comparative advantage?
Comparative advantage is a complicated macroeconomics concept. So, let's use a comparative advantage example to help you understand it.
In this example, we will explore the comparative advantage between two hypothetical countries, namely Country X and Country Y. In particular, we will look at the trade of good A and good B between them.
To calculate the comparative advantage, we need the output of the goods per unit of labor. Unit of labor can be arbitrary, with common ones being working days and the number of workers. The following is the output per unit of good A and good B for Country X and Country Y:
- Output of good A per unit of labor for Country X: 100.
- Output of good B per unit of labor for Country X: 110.
- Output of good A per unit of labor for Country Y: 90.
- Output of good B per unit of labor for Country Y: 80.
Now we can calculate the comparative advantage using the comparative advantage formula below:
comparative advantage = output A / output B
output A- output per unit labor for good A in Country X; and
output B- output per unit labor for good B in Country X.
Please note that the X and Y used in the formula are placeholders and can be replaced with anything else.
In country X, the opportunity cost, or the comparative advantage, of good A is
110 / 100 = 1.1 good B. The opportunity cost of good B in Country X is
100 / 110 = 0.91 good A.
In country Y, the opportunity cost, or the comparative advantage, of good A is
80 / 90 = 0.89 good B. The opportunity cost of good B in Country Y is
90 / 80 = 1.125 good A.
The economics of comparative advantage
The following examples aim to help you understand the concept of comparative advantage further:
- Comparative advantage theory helps countries in specializing.
Let's say that Country Y's costs in producing both good A and good B are lower than Country X, implying that Country Y has absolute advantages in producing both good B and good A compared to Country X. Country Y should still specialize and focus on producing good A and leaves the production good B to Country X. This is because the opportunity cost is lower if you specialise in just one thing, as opposed to trying to master two different goods. This leads to a phenomenon called the benefits of trade, which is explained below.
- Comparative advantage economics helps countries to understand the benefits of trade.
In another example, Country X has a comparative advantage in producing good B, so let's shift 10 working-days from producing good A to producing good B in Country X to illustrate the benefits of trade:
production of good A = 100 * (-10) = -1000 good A
production of good B = 110 * (+10) = +1100 good B
Now, let's shift 10 working-days in Country Y from producing good B to producing good A, considering its comparative advantage in producing good A:
production of good A = 90 * (+10) = 900 good A
production of good B = 80 * (-10) = -800 good B
It is evident that by specializing in good B production, Country X can produce more of good B than its production loss in good A. For Country Y, specializing in good A production allows it to produce more good A than its production loss in good B. Hence, by specializing production according to the comparative advantage, the total output of both countries can be increased.
- There are also weaknesses of comparative advantage theory.
Lastly, it is important to understand that the comparative advantage theory assumes no trading costs between different countries. However, this is often not the case as most countries will impose taxes and tariffs, which vastly increase the trading costs. Hence, it is important to take this into account when you are applying comparative advantage economics in real life.