Determining Your Competitive Advantage

To be successful, farmers must produce the commodity or combination of commodities for which their resources are best suited. Thus, one of the most important choices farm managers make is deciding what to produce.

The first step in making that decision is to make an inventory of the available resources land, labor, capital, and management skills. These resources, along with factors such as location, access to markets, and available technology, will determine a farmer's competitive advantage.

Many farmers arrive at the best mix of products where they have the strongest competitive advantage through experience. Over time, they find that they make more money by increasing the production of commodities for which they are more efficient in comparison to other farmers and by reducing production of commodities for which they are less efficient.

However, the world is always changing and farmers compete not only with their neighbors and farmers in adjacent States, but also with farmers around the world. As a result, farmers must continually reexamine their competitive position in relation to commodities they produce.

In evaluating alternatives, consider two key concepts competitive advantage and comparative advantage. A farmer's competitive advantage is related to, but not entirely determined by, his or her comparative advantage in producing a particular commodity.

Comparative advantage is a concept that refers to the relative efficiency with which resources are used and commodities produced compared to that of other producers. Competitive advantage takes actual market conditions into account; it refers to relationships between the cost at which the product can be supplied and the market price.

We will examine the concept of comparative advantage before turning to the more general consideration of competitive advantage.

Assessing Comparative Advantage

Economists developed the concept of comparative advantage to help people understand their economic niche in society. Comparative advantage, essentially, means comparative efficiency. You have a comparative advantage in doing those things you can do more efficiently than someone else. This may sound simple. But assessing comparative advantage involves measuring efficiency differently than many farmers are used to--not in bushels per acre or pounds of milk per cow, but in tradeoffs.

Tradeoffs occur when you choose one thing over another. You must give up any benefit associated with the alternative you did not choose. In other words, you cannot have your cake and eat it, too. If you spend your money on one thing, you have to give up the satisfaction of whatever else you might have bought instead. Economists refer to the benefit foregone as the opportunity cost the value of the opportunity you must forego when you choose an alternative.

Assessing comparative advantage involves measuring efficiency in terms of the output produced divided by the output foregone:

For example, a farmer may have to give up the opportunity to produce 40 bushels of soybeans to produce 120 bushels of com. The efficiency ratio for corn would be 120 bu/40 bu, or 3. Three bushels of corn would be gained for each bushel of soybeans foregone. The opportunity cost per bushel of corn would be the value, or output, of soybeans (1/3 bushel) foregone for each bushel of corn produced (40 bu/120 bu).

Thus, the crop with the highest efficiency ratio is also the one with the lowest opportunity cost.

Comparative advantage is a comparison of the efficiency of two producers who can produce either of two different products. The producer who is more efficient (has the lower opportunity cost) has a comparative advantage in the production of that commodity.

Farmers Andrews and Brown. Take a simple example of two farmers. Farmer Andrews can produce either 150 bushels of corn per acre or 500 pounds of beef per acre on her land using a given dollar amount of resources. Farmer Brown can produce 100 bushels of corn or 400 pounds of beef on his land with the same dollar amount of resources. So who has a comparative advantage in producing what?

It would be easy if Brown could produce more of one thing and Andrews could produce more of the other. But that is not true in this case. Andrews has a more productive complement of resources, so she can produce more of either beef or corn than can Brown. Andrews is said to have an absolute advantage in both beef and corn. Does this mean that Brown simply cannot compete and will be forced out of the business?

Before we declare bankruptcy for Farmer Brown, let us look at opportunity cost. Andrews' opportunity cost of producing 500 pounds of beef is 150 bushels of corn, the amount of corn she would have to give up if she produces beef instead of corn. Her opportunity cost per 100 pounds of beef is 30 bushels of corn. Brown's opportunity cost of producing 400 pounds of beef is 100 bushels of com. This means that Brown only gives up 25 bushels of corn for each 100 pounds of beef he produces. Thus, Brown's opportunity cost of producing beef is less, and he has a comparative advantage in beef production. Andrews' opportunity cost of producing 150 bushels of corn is 500 pounds of beef or 3.33 pounds of beef per bushel of corn. Brown's opportunity cost for 100 bushels of corn is 400 pounds of beef or 4 pounds per bushel. Thus, Andrews turns out to be the more efficient producer of corn because she gives up fewer pounds of beef per bushel of corn produced. Therefore, Andrews has the comparative advantage for producing corn.

When opportunity costs are used to compare two producers who are each able to produce two alternative crops, one producer will always have a comparative advantage in producing one commodity and the other producer will always have a comparative advantage in producing the other commodity.