Comparative vs. Absolute Advantage in Microeconomics

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  • 0:02 Absolute Advantages
  • 0:57 Comparative Advantages
  • 3:00 Applying Advantages in…
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Instructor: Kevin Newton

Kevin has edited encyclopedias, taught history, and has an MA in Islamic law/finance. He has since founded his own financial advice firm, Newton Analytical.

Ever wonder why economies don't just try to do everything themselves and instead rely on trade as such an important idea? This lesson on comparative vs. absolute advantages helps to explain why.

Absolute Advantages

Say that you had two friends who were interested in starting their own businesses. Jack and Jill are both talents as pizza makers and as photographers, but they have differing abilities. Jack can take 30 pictures in an hour but only cook 2 pizzas. Meanwhile, Jill can take 20 pictures but make 5 pizzas in that same hour. It's not just enough to say that Jill can make more pizzas or that Jack can take more pictures.

Instead, economists use the term absolute advantage. An absolute advantage means that you can do more of something during a given time. That means that in the example, Jack has an absolute advantage in taking pictures, whereas Jill has an absolute advantage in making pizzas. Jill also has permission to send as many of those pizzas as she wants to me.

Comparative Advantages

So let's say that Jack and Jill set up their respective businesses, Jack's Photography and Jill's Pizzeria. Both are chugging away, content in their knowledge that they are working to make exactly what they should make. But then, one day, a brand-new pizza oven magically appears in Jack's shop. Now he can make 6 pizzas in an hour. This means that Jack now has the absolute advantage in both pizza production and photography, and probably a few new friends to boot. But what should he do?

It might be tempting to just look at the absolute advantage, but that is ignoring the costs of the items. In fact, a famous economist named David Ricardo said we shouldn't look at absolute advantage but instead the opportunity cost of doing each. Whoever could do something for the lower opportunity cost, Ricardo reasoned, was the person who could actually do it cheaper. So let's look at those costs.

Each pizza that Jack makes costs him 5 pictures, whereas it only costs Jill 4 pictures to make a pizza. Since Jill can make pizzas for cheaper, she should probably stick to that. Jill has the comparative advantage when it comes to making pizza because she pays a lower opportunity cost.

Now let's look at it from the perspective of photographs. Each photograph costs Jack 20% of a pizza, since he can take 5 photographs in the amount of time he spends making one pizza. On the other hand, each photograph costs Jill 25% of a pizza, since she can take 4 photographs in the amount of time it takes her to make a pizza. Look at the percentages, and you'll see that Jack can take each picture for a lower opportunity cost. As a result, he has the comparative advantage in photography. It's important to know that while someone can have every absolute advantage, they will never have every comparative advantage.

Applying Advantages in Economics

Notice that all the examples that I used above completely lacked any discussion of the money made but instead solely the units produced. This is really important, as it helps to explain a number of very important facts in economics that are easily misconstrued. This is because price is not a direct function of the ability to produce something. That idea helps to separate capitalism from other ideas, namely communism, that say everyone should make the same.

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