We trade with other people every day. When we go for a haircut at the hairdresser’s or at the bakery for bread, we trade with the hairdresser and the baker. The same is true when we work – we trade our work performance with the employer. Trade allows us to specialize and increase productivity, and as a result of that, we all produce more. So we can afford more because the prices are lower.
Although all this seems common sense at the micro-level, when we talk about the behavior of individuals at the macro level, a large number of people will claim that trade is unnecessary and even harmful.
However, most people who are against the idea of international trade will not claim that it is better, easier, and cheaper for you to knead and bake bread and pastries yourself instead of buying it in a bakery. For them, trade is a problem only if the goods cross borders.
What Is the Comparative Advantage Calculator?
Have you ever searched for a tool that will calculate a comparative advantage for you? If you did, you should know that your wish has been granted! A comparative advantage calculator is exactly what you are looking for. It can save you time when calculating the comparative advantage. Read on to learn more about this tool.
Comparative Advantage Formula
Comparative Advantage = output X / output YTo help you understand it better, we will show you an example. In the table down below, you have all the data needed to calculate comparative advantage.
| Output per unit Labor for Good A | 100 |
| Output per unit Labor for Good B | 110 |
In order to calculate the comparative advantage for good A, you will need to use this formula:
Comparative Advantage for Good A = output B / output A
Comparative Advantage for Good A = 110 / 100
Comparative Advantage for Good A = 1.1
If you want to calculate the comparative advantage for good B, you should use this formula:
Comparative Advantage for Good B = output A / output B
Comparative Advantage for Good B = 100 / 110
Comparative Advantage for Good B = 0.91
Difference between Absolute and Comparative Advantage
The principle of comparative advantage is also used in exchanges between several countries – it is known as a multilateral exchange. The benefits of this exchange are great because it allows the deficit to arise in exchange with one country so that it’s covered by a surplus from the exchange with another country.
Comparative advantage is the capability of a country or individual to produce goods more effectively than other countries or people. Relative efficiency is measured by the proportion of the opportunity expenses of making one product to other products. The scheme of comparative advantage (or cost) is indispensable in exhibiting the interest of free trade between national economies and in explaining the design (commodity and regional structure) of the international shops.
The benefits of it are built on the fact that specialization increases productivity, and the fact is that higher productivity allows for the growth of living standards. All countries specialize in those productive activities in which they have a comparative advantage.
By exchanging the goods that each of them produces more efficiently, they can end up with a different combination of consumer goods and greater prosperity. Therefore, each trade restriction diminishes the benefits of specialization.
Example: How Does It Work?
If country A is more productive than country B in the production of apples (it produces the same quality of apples but for a cheaper price), then it has an absolute advantage in the production of raspberries.
Let’s say country A is twice as productive as country B in apple production, but four times more productive in sugar production. Then country B has a comparative advantage over country A in apple production although country A has an absolute advantage and has a comparative advantage in sugar production.
Comparative advantages in foreign trade mean relative advantages. Even if you are weaker in the production of every commodity, you can have comparative advantages. Or if you are better, then you have comparative advantages only in what you are better at.
The consequence of this is that country A will import apples from country B, and export sugar to country B. Although it is more competitive in apples, country A will import them because it is better at other things. The best scenario for these two countries would be that country A directs all of its resources to sugar, while country B does the same for apples. Then they need to make a trade between each other. This way, they would achieve the best result overall.
While this is not such an obvious thing, it is reliably true. Foreign trade is very important and beneficial, which is why everyone wants to participate in it – even those who are less competitive. That being said, competitiveness (or we can call it productivity) is not crucial for foreign trade. You can also export something in which you are less competitive.
The Theory of Comparative Advantage
Insisting on bilateral balance in multilateral exchange is unnecessary or even harmful sometimes. The theory of comparative advantage has some limitations and the biggest drawback is that it assumes the smooth functioning of the flexible pricing in a competitive market doesn’t result in involuntary unemployment.
However, when a crisis occurs, one cannot be sure that the country will benefit from the exchange. That country will benefit from the exchange only if the theory of comparative advantage is valid.
In addition, the benefits of international exchange are not distributed equally. The theory claims that benefits always overshadow the losses that may occur, whereas economists believe that protectionism is not a reasonable economic policy. When foreign trade experts do not understand the concept of comparative advantage, then they usually think that the solution to the problem is the state, chamber of commerce, or strategy.
New trade theory shows that comparative advantage is not necessary for the existence of profitable trade between countries. This is especially true when they specialize in production associated with non-constant yields or trade in differentiated products.