How are opportunity cost and comparative advantage interlinked? What is mean by opportunity cost? How does opportunity cost influence decisions? Why are they important for free trade? If you think that these questions are worthwhile, then, let’s begin to explore..
“Scarcity–choices–opportunity cost–comparative advantage–specialisations–economies of scale–free trade system”
Description and meaning of opportunity cost
In our daily activities, many a times, you might have encountered with various products you purchased or sold out. These products have printed price tags and interested person has to pay or receive it. But, in economics perspective, the price that is printed isn’t actual cost because it isn’t with the costs that you are going to lose when you go for it.
Actually, the cost of product you are purchasing is something more than the printed one. It includes costs of opportunities that you might have enjoyed if you think otherwise. Simply, opportunity cost is a potential cost that a person sacrifices if he or she thinks to purchase anything.
Role and examples of opportunity cost
Suppose, David is a 10th class student. On holiday, he does part time job to distribute newspapers. By doing so, he earns $50 per week.
One day, he instead job, goes to watch a circus. As he reach there, he notices many children enjoying. Today, he has $100 and he has to manage ticket, fare, and snacks. Ticket is of $65 and he needs some $30 for fare. Finally, it remains only $5 for snacks.
Generally, he loves to have sea food.
But, now, he has only $5 for snacks and so, can’t afford. At last, after some brainstorming, he goes for simple one to enjoy circus show. In this way, he sacrifices the desire to have sea food, and prefers to watch show. If he had more money, David would have definitely enjoyed his favorite sea food on special occasion.
In another one possibility, had he thought to watch movie, instead of circus, he might have enjoyed his favorite snacks. “So, to watch circus, David pays much more than the actual cost of ticket. He pays cost of ticket + cost of fare + cost of satisfaction that he would have experienced, if he had more dollars”
This is what I want make you known about “Opportunity cost”. In simple terms, it is the potential cost that a person gives up to purchase something else.
Relationship between opportunity cost and comparative advantage
Unequivocally, opportunity cost act as a determinant or basis for comparative advantage. More the opportunity cost, lesser the advantage, and vice versa.
For more clarity, suppose, a firm used to produce a goods in which that firm has greater advantage means lower opportunity cost compare to trading competitor. Then only, the product of that firm could capture better market access, and so the more market share.
Hence, to have a great comparative advantage, firm need to have better factors of production or expertise.
Free trade and comparative advantage relations
As I discussed in the previous blog, that comparative advantage paves the way for more specializations. Consequently, mass production and economies of scale affect bring down prices much lower.
“Lower prices–easier market access–more market share–greater consumer saving–higher standards of living and investment for production”
Finally, the above shown cycle goes on until the firm has comparative advantage.
Solved questions on opportunity cost and comparative advantage
Let’s take a look at the following solved questions for more clarity of topic.
Q.1. What is comparative advantage?
Ans: It is all about to exploit the benefits of cost difference in the factors of production. Suppose, if a nation has an economic edge over competitor in the international market. Expectedly, product of that nation remains cost effective than trading partner.
Simply, it is called advantage for a particular nation comparative to other trading member in terms of that product.
Q.2.Why comparative advantage is so important?
Ans: Nowadays, business without profit seems too hypothetical to trust. In this race everyone strive to prove his or her superiority. So, having a comparative advantage over competitor is necessity now.
Q 3. What is Better off Vs worse off with or without comparative advantage
Ans: When these two trading partners decide to produce things in which they don’t have any economic edge, they have to pay more cost.
Here, more cost mean, instead to make $100 product, they are bound to produce $10 product by investing higher wages. Consequently, product would be lesser competitive.
Instead to do this, they can purchase it from China to save expensive labor and expertise. By doing so, they can save resources and concentrate on the product in which they have greater edge.
Similarly, China can purchase products in which it has no advantage. Instead, can concentrate on things with greater advantage to sell in the global market.
This is all about the opportunity cost and comparative advantage. Both are interdependent and interlinked with each other.
Opportunity cost and comparative advantage
Positive comparative and superlative degrees
Economies Of Scale and mass production