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Basketball genius Michael Jordan stars in one example sometimes used in textbooks and classrooms: If Jordan mows his lawn faster than anyone else in the neighborhood, he has an absolute advantage in lawn mowing. But that doesn’t mean that he should mow his neighbor John Smith’s lawn, because that would come at an opportunity cost: in the same two hours it would take Jordan to cut the grass, he could earn much more by playing basketball or making a commercial. While it is difficult to measure comparative advantage in world trade, one indicator is something called “Revealed Comparative Advantage” (RCA). This is a measure of how a country’s exports compare to those of a bigger group, such as a region or the rest of the world. For example, if a country’s RCA in wheat is high (typically greater than one), that means wheat makes up a higher share of that country’s total exports than it does of the world’s exports. This suggests that that country is a more efficient wheat-producer than the average country. But countries don’t always produce the products in which they have a revealed comparative advantage. Sometimes Michael Jordan mows the lawn. Let’s take a look at a couple of examples from this new data visualization tool. Fuels are Saudi Arabia’s top export, and it has a high revealed comparative advantage in fuels. The country is exporting what it should. Ricardo would be pleased.
Georgia, on the other hand, is a different story. The RCA evidence suggests that Georgia is a better-than-average producer of minerals. But the country’s top goods export is transportation equipment, a category that includes vehicles, railway locomotives, and auto parts and accessories. Indeed, three of the country’s top five product exports are automobiles, according to trade statistics at a fairly detailed level.
What could be the reason for this discrepancy? Why would a country export en masse something that other countries produce more efficiently? There is plenty of room to speculate. For example, distortive government policies, such as trade barriers, could encourage the inefficient growth of a specific sector or change the mix of a country’s exports, as could high trade costs associated with the transport of goods or clearance at the border. In Georgia’s case, it seems that both international relations and government reforms in the last decade have made it relatively easier for traders to import and export used cars. In 2013, Russia removed a ban on Georgian exports, according to the World Bank’s country program snapshot. In addition, demand for used cars increased among countries such as Kazakhstan and others in the Commonwealth of Independent States. Finally, a combination of lower tariffs and simplified customs procedures in Georgia has lowered the costs of trading used cars, according to a team of young economists at the International School of Economics in Tblisi, Georgia. All of this has created a “bonanza” for Georgia’s used car salesmen, and a surge in the country’s car exports. Click here or explore the options below to get a hint of what your country’s story might be. Would it make Ricardo proud? Exports vs. RCA Compare your country's exports to its revealed comparative advantage. Note: The product aggregation was done using HS 1988/92 or H0 classification. For a complete list download the Excel file or visit the product metadata page in WITS. A country can produce a good or service at a lower opportunity cost than the other country What is a Comparative Advantage?In economics, a comparative advantage occurs when a country can produce a good or service at a lower opportunity cost than another country. The theory of comparative advantage is attributed to political economist David Ricardo, who wrote the book Principles of Political Economy and Taxation (1817). Ricardo used the theory of comparative advantage to argue against Great Britain’s protectionist Corn Laws, which restricted the import of wheat from 1815 to 1846. In arguing for free trade, the political economist stated that countries were better off specializing in what they enjoy a comparative advantage in and importing the goods in which they lack a comparative advantage. What is an Opportunity Cost?To understand the theory behind a comparative advantage, it is crucial to understand the idea of an opportunity cost. An opportunity cost is the foregone benefits from choosing one alternative over others. For example, a laborer can use one hour of work to produce either 1 cloth or 3 wines. We can think of opportunity cost as follows: What is the forgone benefit from choosing to produce one cloth or one wine? Therefore:
Comparative Advantage and Free TradeComparative advantage is a key principle in international trade and forms the basis of why free trade is beneficial to countries. The theory of comparative advantage shows that even if a country enjoys an absolute advantage in the production of goods, trade can still be beneficial to both trading partners. Practical Example: Comparative AdvantageConsider two countries (France and the United States) that use labor as an input to produce two goods: wine and cloth.
The information provided is illustrated as follows: It is important to note that the United States enjoys an absolute advantage in the production of cloth and wine. With one labor hour, a worker can produce either 20 cloths or 20 wines in the United States compared to France’s 5 cloths or 10 wines.
To determine the comparative advantages of France and the United States, we must first determine the opportunity cost for each output: France:
The United States:
When comparing the opportunity cost of 1 cloth for both France and the United States, we can see that the opportunity cost of cloth is lower in the United States. Therefore, the United States enjoys a comparative advantage in the production of cloth. Additionally, when comparing the opportunity cost of 1 wine for France and the United States, we can see that the opportunity cost of wine is lower in France. Therefore, France enjoys a comparative advantage in the production of wine. Comparative Advantage and its Benefits in Free TradeHow does identifying each country’s comparative advantage aid in understanding its benefits in free trade? First, let’s assume that the maximum amount of labor hours is 100 hours. In France:
In the United States:
Following Ricardo’s theory of comparative advantage in free trade, if each country specializes in what they enjoy a comparative advantage in and imports the other good, they will be better off. Recall that:
In France, the country specializes in wine and produces 1,000 barrels. Recall that the opportunity cost of 1 barrel of wine in the United States is 1 piece of cloth. Therefore, the United States would be open to accepting a trade of 1 wine for up to 1 piece of cloth. The potential gains from trade for Europe by specializing in wine is represented by the arrow: In the United States, the country specializes in cloth and produces 2,000 pieces. Recall that the opportunity cost of 1 piece of cloth in France is 2 barrels of wine. Therefore, France would be open to accepting a trade of 1 cloth for up to 2 barrels of wine. The potential gains from trade for the United States by specializing in cloth is represented by the arrow: Therefore, using the theory of comparative advantage, a country that specializes in their comparative advantage in free trade is able to realize higher output gains by exporting the good in which they enjoy a comparative advantage and importing the good in which they suffer a comparative disadvantage. Related ReadingsThank you for reading CFI’s guide to Comparative Advantage. To keep advancing your career, the additional CFI resources below will be useful:
When a country can produce a product at a lower opportunity cost than another country?In economics, a comparative advantage occurs when a country can produce a good or service at a lower opportunity cost than another country. The theory of comparative advantage is attributed to political economist David Ricardo, who wrote the book Principles of Political Economy and Taxation (1817).
When a country can produce a good at a lower opportunity cost than another country that country has a ___ in that good?Comparative advantage occurs when one person or producer can produce at a lower opportunity cost than another person or producer.
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When one country can produce a product with a lower opportunity cost than another country it is said to?
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