What is the difference between absolute advantage and comparative advantage?
A country, firm, or individual has an absolute advantage when it can produce a good or service more efficiently than another country, firm, or individual. If one country can produce 100 automobiles and another country can only produce 50 automobiles in the same amount of time, the first country has an absolute advantage. A country can have an absolute advantage in zero goods, one good, or even all goods.
Comparative advantage is different. A country has a comparative advantage if it can produce a good or service relatively more efficiently than another country. We compare two goods when talking about comparative advantage, like producing cars and airplanes. A country cannot have a comparative advantage in both goods, since the test is which one it can produce more efficiently.
How do I figure out which good a country or party has a comparative advantage between two goods?
Imagine you have two countries, the United States and Germany. The United States can make 10 cars per day and 4 airplanes. Germany can make 7 cars per day and 3 airplanes. In order to find which good the United States has a comparative advantage in, we must figure out the ratio of production of each good. First, the United States can make cars at a ratio of 10 to 7 compared to Germany, or 10 divided by 7. That equals 43% more efficiently than Germany. Next, the United States can make cars at a ratio of 4 to 3, or 4 divided by 3, which equals 33% more efficiently.
To find comparative advantage, you look at which good can be produced more efficiently. Since 43% is greater than 33%, the United States has a comparative advantage in producing cars. It should specialize in producing cars and trade with Germany for airplanes. This way it will end up with more of both than if it were to try to produce both on its own.
What does opportunity cost mean?
Opportunity cost refers to what you have to give up to buy what you want in terms of other goods or services. The opportunity cost of not trading with another country is that the first country has given up any gains it could have made from trade.
Can a country that doesn't have an absolute advantage in production gain from trade?
Yes, any country that has a comparative advantage can gain from trade. And since a comparative advantage always exists in the production of two goods compared between countries, even countries without an absolute advantage in production can gain from trade.