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Absolute Advantage

Absolute Advantage is where an entity is better in terms of output at doing something than another entity. For example Italy might be better at producing Pasta than China; therefore Italy has an absolute advantage at producing pasta.

One might assume therefore that people should specialise at something that they have an absolute advantage in. David Ricardo showed this isn't necessarily true due to comparative advantages.

Comparative Advantage

Comparative Advantage is where an entity is always comparatively better at one thing than another entity. For example lets say Italy can produce 100 units of pasta and 70 units of rice, whereas China can produce 50 units of pasta and only 20 units of rice. Obviously Italy has the absolute advantage because it can produce more of both goods. However comparative advantage takes into account the opportunity cost of producing a good. For Italy to produce 10 units of pasta, the opportunity cost is 7 units of rice. However for China to produce 10 units of pasta, the opportunity cost is 4 units of rice. Therefore it is beneficial for China to produce pasta (as it can only make 4 units of rice instead of the 7 that Italy can make) and Italy to produce rice. This is because it would reduce the opportunity cost of producing, and the 2 entities could trade and would both benefit.

Another example is a lawyer is paid £100 an hour. He can type 80 words a minute. He hires a secretary for £12 an hour but she can only type 60 words a minute. If he decides to fire her and type the letters himself – because he is slightly quicker – he will be worse off even though he has the absolute advantage. He has the comparative advantage at being a lawyer and the secretary has the comparative advantage at typing. If the lawyer decided he would be also do the secretary work, and he writes a report taking him 15 minutes, (it would take the secretary 20 minutes to write it) he (the lawyer) looses out because it would only cost him £4 to hire the secretary to write the report whereas he could be earning £25 in the time it would take him to write the report. Therefore if he specialises at law and hires the secretary to specialise in her comparative advantage then both are better off. The secretary is earning £12 a hour – better than being unemployed – and the lawyer is earning £100 an hour – better than trying to be a lawyer and a secretary!

Page last updated on 20/10/13