Competitive Advantage

by Mr. Cheap

I couldn’t find an explaination of competitive advantage that I liked, so I quickly wrote this up myself. If anyone has a link to a good on-line description of this, please post it as a comment below.

Say there are two companies (or countries, or people) producing red widgets and blue widgets. Lazy company makes red widgets for $20 each and blue widgets for $10 each. Productive company makes both types of widgets for $8 each. Assuming the two companies can trade with each other in order to maximize their numbers of both widgets, what is the best widget for each to produce?

One argument would be that Productive company shouldn’t trade at all and just produce all its own widgets (since it can produce both cheaper than Lazy company). This is a mistake.

Say Lazy company produces 10 blue widgets (costing it $100) and Productive company produces 10 red widgets (costing it $80). If lazy company then trades Productive company 5 blue widgets for 4 red widgets both are now better off. Lazy company has 5 blue widgets and 4 red widgets (which would have cost it $130 to make itself, but instead it got them for $100) and Productive company now has 6 blue widgets and 5 red widgets (which would have cost it $88 to produce, but instead it got them for $80).

Both companies are better off after the trade (otherwise why would they have made the deal?) and have more widgets for a lower cost. Lazy company, in spite of have greater productions costs, has a COMPETITIVE ADVANTAGE producing blue widgets.

Socialists would say that Productive company is taking advantage of lazy company (because it has more widgets for lower cost), and since it has more efficient production methods it should give widgets to Lazy company (and this is at the core of why I hate socialists).

Any time there is a difference in production abilities, a competitive advantage will occur which allows everyone to be better off if they focus on what they have an advantage producing then trade with the other producers (and this is why trade isolation is silly and destructive).

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