When a person or a country has comparative advantage in something, they have a lower opportunity cost for the production of a certain item than other people or countries. In other words, they are giving up less to produce a certain item than others.

A particular useful model of gains from trade (benefits through trading with others) is based on this concept of comparative advantage.

• Since Luxembourg only gives up two chairs for every HDTV it makes, while Thailand gives up four chairs for every HDTV it makes, then Luxembourg has the comparative advantage in making the HDTVs. Therefore, Luxembourg should specialize in making the HDTVs.
• On the other hand, Thailand only gives up one-fourth of an HDTV for every chair it makes, while Luxembourg has to give up one-half of an HDTV for every chair it makes. Therefore, Thailand has comparative advantage and should specialize in producing the chairs since they have a lower opportunity cost at making them.
• With specialization and trade, Luxembourg will be able to consume three extra chairs, while Thailand will be able to consume an extra chair and an extra HDTV.

Absolute Advantage, Comparative Advantage, and International Trade

• Between these two, Luxembourg has the absolute advantage. This means it can produce more or do better than Thailand even if they did not trade. The United States, for example, also has absolute advantage, or in other words, they have the ability to produce more or do better than many other countries.
• However, although one country has absolute advantage over something, it can still be very beneficial to trade, since gains from trade is based on comparative advantage. This is why the United States, although it's productivity is a lot higher than many countries, still trades with these countries.
  

Economic Models | Production Possiblities Frontier | Comparative Advantage | Circular Flow Diagram | Uses of Economic Models