Absolute and comparative advantage
Why the person who is better at everything still gains from trade, worked through with Mankiw's farmer and rancher.
FinanceA company's marketAbout 5 min: 3 reading, 2 practiceUpdated
General education, not financial advice.
- Tell absolute advantage from comparative advantage
- Work out each producer's opportunity costs from a table of times
- Identify who has the comparative advantage in each good
Builds toward: Judge a company. Read a company's accounts, apply Graham's tests, and make a rough valuation.
A company's market: pricing power, taxes and trade: lesson 9 of 15
- A company's market
- Price elasticity of demand 6 min
- Elasticity and total revenue 5 min
- Consumer and producer surplus 4 min
- Market efficiency 5 min
- Price ceilings and floors 6 min
- Who really pays a tax 5 min
- Deadweight loss 5 min
- How tax size changes the loss 5 min
- Absolute and comparative advantage 5 min
- Why trade helps both sides 5 min
- Winners and losers from trade 5 min
- Tariffs and quotas 5 min
- What makes productivity grow 5 min
- Growth policy 5 min
- Why unemployment exists 6 min
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Pairs with any introductory economics textbook; for example N. Gregory Mankiw, Principles of Macroeconomics (6th ed.), chapter 3
What it is
Mankiw's example has two people and two foods. Each works 8 hours a day.
| Minutes per ounce | Meat | Potatoes |
|---|---|---|
| Farmer | 60 | 15 |
| Rancher | 20 | 10 |
In 8 hours (480 minutes), working on one food only, the farmer could make 8 ounces of meat or 32 of potatoes; the rancher 24 of meat or 48 of potatoes.
Absolute advantage compares inputs: the producer who needs less to make a good has the absolute advantage in it. The rancher is faster at both, so has the absolute advantage in both meat and potatoes.
Comparative advantage compares opportunity costs: the producer who gives up less of the other good to make a good has the comparative advantage in it.
Quick check
Tap an answer to check it.
Who has the absolute advantage in potatoes?
- The farmer is slower at potatoes too
Show answer
The rancher: 10 minutes an ounce against the farmer's 15. Absolute advantage compares the inputs needed.
Why it matters
Opportunity costs turn the comparison round. Time spent on one food is time not spent on the other:
- Farmer: an ounce of potatoes takes 15 minutes, in which they could have made ¼ ounce of meat. So 1 ounce of potatoes costs ¼ ounce of meat, and 1 ounce of meat costs 4 ounces of potatoes.
- Rancher: an ounce of potatoes takes 10 minutes, in which they could have made ½ ounce of meat. So 1 ounce of potatoes costs ½ ounce of meat, and 1 ounce of meat costs 2 ounces of potatoes.
| Opportunity cost of 1 ounce of | Meat | Potatoes |
|---|---|---|
| Farmer | 4 oz potatoes | ¼ oz meat |
| Rancher | 2 oz potatoes | ½ oz meat |
So the farmer has the comparative advantage in potatoes (¼ is less than ½), and the rancher in meat (2 is less than 4).
One person can have the absolute advantage in both goods, but no one can have the comparative advantage in both: one good's opportunity cost is the inverse of the other's, so a lower cost in one means a higher cost in the other. That is why, whenever opportunity costs differ, everyone has something to gain from specialising.
Text description
Two straight-line production possibilities frontiers, potatoes across and meat up. The farmer's runs from 8 ounces of meat to 32 ounces of potatoes; the rancher's runs from 24 ounces of meat to 48 ounces of potatoes. The rancher's frontier lies outside the farmer's (absolute advantage in both), but the lines have different slopes: an ounce of meat costs the farmer 4 ounces of potatoes and the rancher only 2. The dots mark what each makes and eats without trade: 16 potatoes and 4 meat for the farmer, 24 potatoes and 12 meat for the rancher.
Worked example
From a table of times, opportunity cost is a ratio of times.
Ama can type a page in 10 minutes and translate a page in 30. Ben types a page in 20 minutes and translates a page in 40.
- Ama: a translated page costs 30 ÷ 10 = 3 typed pages; a typed page costs ⅓ translated page.
- Ben: a translated page costs 40 ÷ 20 = 2 typed pages; a typed page costs ½ translated page.
Ama is faster at both (absolute advantage in both). But Ben gives up less to translate (2 typed pages against 3), so Ben has the comparative advantage in translating, and Ama in typing (⅓ against ½).
Common mistake
Thinking that someone better at everything has nothing to gain from trade. Advantage in trade comes from opportunity cost, not speed. Because each person's cost of one good is the inverse of their cost of the other, whenever their costs differ each has a comparative advantage in something.
Key terms
- absolute advantage
- the ability to produce a good using fewer inputs than another producer
- comparative advantage
- the ability to produce a good at a lower opportunity cost than another producer
- opportunity cost
- whatever must be given up to obtain something
- specialisation
- concentrating on the goods in which one has a comparative advantage
Practise the key terms
Tap a card to turn it over. 4 cards.
| Front | Back |
|---|---|
| absolute advantage | the ability to produce a good using fewer inputs than another producer |
| comparative advantage | the ability to produce a good at a lower opportunity cost than another producer |
| opportunity cost | whatever must be given up to obtain something |
| specialisation | concentrating on the goods in which one has a comparative advantage |
Practice
Work it through
Country X makes a car with 4 units of labour and a tonne of grain with 2. Country Y makes a car with 6 units and a tonne of grain with 2.
- 4 ÷ 2
- 6 ÷ 2
- 2 ÷ 4
- 2 ÷ 6
Quick quiz
Tap an answer to check it.
In the last exercise, who has the comparative advantage in cars?
- Y gives up more grain for each car
- Comparative advantage depends on opportunity cost, which differs
Show answer
X: a car costs it 2 tonnes of grain, against 3 for Y. The lower opportunity cost decides.
In Mankiw's example, who has the comparative advantage in potatoes?
- Speed gives absolute advantage, not comparative advantage
Show answer
The farmer: an ounce costs ¼ ounce of meat, against ½ for the rancher. Comparative advantage is about opportunity cost.
Can one producer have the comparative advantage in both of two goods?
- That is absolute advantage in both
Show answer
No: the opportunity cost of one good is the inverse of the other's. A lower cost of one good always means a higher cost of the other.
In short
- Absolute advantage: fewer inputs. Comparative advantage: lower opportunity cost.
- Opportunity cost comes from the ratio of the times (or inputs) needed.
- One producer can have the absolute advantage in both goods, but not the comparative advantage in both.
- So, whenever costs differ, everyone has a comparative advantage in something.
Mastery check
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Check yourself
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In Mankiw's example, what does 1 ounce of meat cost the rancher?
Show answer
2 ounces of potatoes.
What does comparative advantage compare?
Show answer
Opportunity costs.
In 8 hours, how many ounces of potatoes could the farmer make, working on potatoes only?
Show answer
32 (480 ÷ 15).
Further reading
- N. Gregory Mankiw, Principles of Macroeconomics, 6th ed. (South-Western Cengage, 2012), chapter 3.
- On this site: Trade-offs and opportunity cost and Why trade helps both sides.
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