What is The Theory of Comparative Advantage?

Welcome to the Investors Trading Academy talking glossary of financial terms and events.
Our word of the day is “Comparative advantage”
The theory of comparative advantage says that it pays countries to trade because they are different. It is impossible for a country to have no comparative advantage in anything. It may be the least efficient at everything, but it will still have a comparative advantage in the industry in which it is relatively least bad.
There is no reason to assume that a country’s comparative advantage will be static. If a country does what it has a comparative advantage in and sees its income grow as a result, it can afford better education and infrastructure. These, in turn, may give it a comparative advantage in other economic activities in future.
It is also one of the oldest theories in economics, usually ascribed to David Ricardo. The theory underpins the economic case for free trade. But it is often misunderstood or misrepresented by opponents of free trade. It shows how countries can gain from trading with each other even if one of them is more efficient – it has an absolute advantage – in every sort of economic activity. Comparative advantage is about identifying which activities a country or firm or individual is most efficient at doing.

By Barry Norman, Investors Trading Academy – ITA