Comparative Advantage

Comparative Advantage
A situation in which a country, individual, company or region can produce a good at a lower opportunity cost than a competitor.

Let's break this down into a simple example. Suppose that two firms both produce two main products: ice cream and bicycles. The first firm, the Danish Ice Cream and Bicycle Co., is located in Denmark, where dairy milk is abundant; the second firm, the Gobi Ice Cream and Bicycle Co., is smack in the middle of the Gobi Desert.

The Gobi Ice Cream and Bicycle Co. must spend a lot of money to make ice cream, whereas the Danish Ice Cream and Bicycle Co. spends way less to produce the same amount. The two firms are dead even in their production costs for bicycles.

Because the Danish Ice Cream and Bicycle Co. has a comparative advantage with ice cream production, it should probably consider turning exclusively to ice cream. Along the same vein, the Gobi Ice Cream and Bicycle Co. should probably give up the ice cream and focus on the product in which it is the least disadvantaged (bicycles).

Investment dictionary. . 2012.

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