Definition
Comparative Advantage
Comparative advantage is the principle that countries gain by specialising in goods they produce at the lowest opportunity cost and trading for the rest, even if one is better at everything.
David Ricardo's insight is that trade benefits both parties when each focuses on what it gives up least to produce. India's comparative advantage in IT services and pharmaceuticals lets it specialise and import goods where it is relatively less efficient.
Unlike absolute advantage (being best at something), comparative advantage rests on opportunity cost, which is why even a less-productive country still gains from trade. It underpins the entire case for global specialisation and free trade.
Related terms
- Absolute AdvantageAbsolute advantage is the ability to produce a good using fewer resources than another producer; it differs from comparative advantage, which is based on opportunity cost.
- Terms of TradeTerms of trade is the ratio of a country's export prices to its import prices; rising terms of trade mean exports buy more imports, improving national income.
- Opportunity CostOpportunity cost is the value of the next-best alternative you give up when you choose to use money (or time) one way rather than another.
- Balance of Payments (BoP)The balance of payments records all economic transactions between India and the rest of the world over a period, spanning trade, services, income and capital flows.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.