Comparative Advantages in Business

I’ve been reading all about comparative advantages lately. What makes something a comparative advantage? What’s the difference between an absolute advantage and a competitive advantage for that matter?

The first thing I did was go to the Wikipedia of course and I found it grossly disappointing. I found it immediately boring and the only example given was about why two countries (invariably Portugal and England) should trade products. This is quite handy but in my world I deal with companies and people. Not countries.

Arnold Kling writes a superb article about comparative advantage: Read this article.

I’ll quote from his article:

About twenty years ago, when I was working at the Federal Reserve Board, an economist colleague built a deck for his house. Apparently, he was fairly skilled, and he may have been able to build it faster than a contractor. That is, the economist had an absolute advantage at building decks.

Nonetheless, I argued that his do-it-yourself approach was indicative of market failure. “If you could work additional hours as an economist and pay a contractor to build your deck, you would be better off,” I contended.

Even though the economist may be a more efficient deck-builder than a contractor, the economist should be doing economics rather than building decks. After all, the economist also is more efficient than the deck-builder when it comes to analyzing the costs and benefits of using peak-load pricing for wire transfers.

If you’ve ever looked for a reason why you should hire someone to clean your house or mow your lawn this is it folks.

The reverse side of this is that I firmly believe in doing things yourself. Whether for the cost savings or the learning involved. Sometimes weeding the garden yourself is worth it.

This principal also brings to mind what everybody says about specializing in business. I like to think that specializing is more about doing what you are the very best at (and removing those items you aren’t) and less about specializing in an industry just for the sake of market share because you are a percieved expert.

What’s your comparative advantage?

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5 responses to “Comparative Advantages in Business”

  1. Specialisation may be good for the economy, but I think it means we lose something as individuals. The economist gets more out of building the deck himself than merely getting the deck built, which would be the case if he simply hired someone to do it for him.

  2. I know that and that’s a good point (the individual benefit) however it applies in a number of ways.

    This is exactly why companies come to us to buy a web site. We’re good at it and they aren’t even though they could make one if they spent a lot of time at it. When they hire us they get a better product and we free them up to make money the way they do it best.

  3. Chris – Nice write up. The theory of comparative advantage sounds very similar to the theory of opportunity costs – with the exception that it is geared towards a macroeconomic business situation rather than a general situation.

    BTW, it is never a bad idea to indulge in something outside your field if it brings you personal satisfaction – that is until it begins to hinder your company’s productivity.

  4. comperative advantage is good because it allows countries, companies and individuals to specialize in the goods they can produce at the cheapest cost.Without comperative advantage, companies will not make enough profits as they will waste time producing even the goods thatare costly to produce in terms of time, money and resources.

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