What is Comparative Advantage Formula?

David Ricardo developed the equation for calculating comparative advantage in 1817. It is calculated by finding the opportunity cost for a set of goods. Suppose two neighboring countries produce two sets of similar goods. So to find out the comparative advantage for those two goods, we need to find out the opportunity cost for producing one good over the other good as the number of skilled labor is the same. Comparative advantage is calculated as

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This formula will help us calculate the opportunity cost for product A; similarly, we need to calculate the opportunity cost for product B. We will do that for both countries. We will be able to determine the comparative advantage of a particular good for a country compared to others by looking at the product of the formula.

Examples of Comparative Advantage Formula

Let’s see some simple to advanced examples of Comparative AdvantageExamples Of Comparative AdvantageThe economic principle of comparative advantage holds in the case of free trade. The countries specialize in producing goods and services that they can make more efficiently with lower opportunity costs than other goods and services. Its examples are - cost, labour, production efficiency, agriculture and industrial.read more Equation to understand it better.

Example # 1

Let us try to understand the concept of comparative advantage with the help of an example. Suppose the two neighboring countries, Italy and France, produce wine and manufacture clothes. Let us try and find out which country has a comparative advantage over the other for these two goods. The quantity of each good for each country is presented below. For Italy, the opportunity cost for producing wine is 1.28 yards of cloth, and the opportunity cost for manufacturing a yard of cloth will be .82 bottles of wine. For France, the opportunity cost for producing wine is .86 yards of cloth, and the opportunity cost for manufacturing a yard of cloth will be 1.17 bottles of wine. On an absolute basis, Italy produces a higher quantity of both goods. But on a comparative basis, the opportunity cost for producing a cloth concerning wine is lesser, so Italy should produce more cloth. Similarly, on a comparative basis for France, the opportunity cost for producing wine concerning cloth is lesser, so Italy should produce more wine.

Below is given data for the Calculation of the Comparative Advantage formula.

Suppose Italy ends up producing only cloth as Italy has the comparative advantage of producing cloth over France, and France ends up producing only wine as France has the comparative advantage of producing cloth over Italy. Let us see how that will increase the total economic output for both countries.

Suppose Italy has seven working days and France has nine worker days.

Calculation of Italy’s Quantity of Wine

The quantity of wine produced will be -7*430

=-3010

Calculation of Italy’s Quantity of Cloth

The number of yards of cloth manufactured will be 7*550

=3850

Calculation of France’s Quantity of Wine

The quantity of wine produced will be 9*350

=3150

Calculation of France’s Quantity of Cloth

The number of yards of cloth manufactured will be -9*300

=-2700

So the net result for the output for these goods for these two countries will be higher production of wine by (-3010+3150) = 140 bottles of wine and (3850-2700) = 1150 yards of cloth.

Example # 2

Oil-producing countries like countries that are part of OPEC have a comparative advantage for producing a lot of chemicals. Many chemicals are by-products of crude oil for which they have huge reserves. So a country that is producing crude has a comparative advantage over a country that is not producing crude in terms of manufacturing chemicals.

Example # 3

A country like India has a huge comparative advantage compared to the western country in terms of the outsourcing industries. Since India has a huge population of young educated English-speaking people, this acts as an advantage to provide scale and price competitiveness, resulting in a lot of work being outsourced in India.

Relevance and Use of Comparative Advantage Formula

It is important to figure out the comparative advantage for goods among countries. Countries produce goods in the region or country with a higher comparative advantage due to labor, population, or the overall ecosystem. As we have seen in the example above, if counties produce based on their comparative advantages, then the total output in the economy for both countries can be higher. In a way, it enhances the chance of much improved global trade between the two countries. In today’s age of It is important to figure out the comparative advantage for goods among countries. As we have seen in the example above that if counties produce on the basis of their comparative advantages then the total output in the economy for both countries can be higher. This in a way enhances the chance of the much improved global trade between the two countries. In today’s age of globalizationGlobalizationGlobalization is defined as the extension of trade, commerce and culture of an economy across different nations.read more, comparative advantage plays a major role.

This has been a guide to Comparative Advantage Formula. Here we discuss how to calculate comparative advantage using its formula and examples and a downloadable excel template. You can learn more about financing from the following articles –

  • Examples of Opportunity CostExamples Of Opportunity CostOpportunity Cost is the benefit that an individual is losing out by choosing one option instead of another option. Let us suppose that a person has $50000 in his hand and he has the option to keep it with himself at home or deposit in the bank which will generate interest of 4% annually so now the opportunity cost of keeping money at home is $2000 per year.read moreAbsolute Advantage vs Comparative Advantage – CompareEconomic ProfitComparative Income StatementComparative Income StatementA comparative income statement is an income statement in which income statements from various periods are dealt with and compared side by side, allowing the reader to compare incomes from prior years and make investment decisions on whether or not to invest in the firm.read more