Absolute vs. Comparative Advantage: An Overview
Absolute advantageandcomparative advantageare two important concepts in economics and international trade. They largely influence how and why nations and businesses devote resources to the production of particular goods and services. Absolute advantage describes a scenario in which one entity can manufacture a product at a higher quality and a faster rate for a greater profit than another competing business or country can accomplish. Comparative advantage, on the other hand, takes into consideration the opportunity costs involved when choosing to manufacture multiple types of goods with limited resources.
Key Takeaways
- Absolute advantage and comparative advantage are two concepts in economics and international trade.
- Absolute advantage refers to the uncontested superiority of a country or business to produce a particular good better.
- Comparative advantage introduces opportunity cost as a factor for analysis in choosing between different options for production diversification.
- Economist Adam Smith helped develop the concepts, suggesting that countries can specialize in goods they can produce efficiently and trade with others for goods they can't produce nearly as well.
- David Ricardobuilt on Smith's concepts by introducing comparative advantage, saying countries can benefit from trade even when they have absolute advantage in producing everything.
What Is The Difference Between Comparative Advantage And Absolute Advantage?
Absolute Advantage
The differentiation between the varying abilities of companies and nations to produce goods efficiently is the basis for the concept ofabsolute advantage. As such, absolute advantage looks at the efficiency of producing a single product. It also looks at how to produce goods and services at a lower cost by using fewer inputs during the production process when compared to the competition.
This analysis helps countries avoid producing goods and services that would yield little to no demand, which would ultimately lead to losses. A country’s absolute advantage (or disadvantage) in a particular industry can play an important role in the types of products it chooses to produce. Some of the factors that can lead an entity to absolute advantage include:
- Lower labor costs
- Access to an abundant supply of (natural) resources
- A larger pool of available capital
As an example, if Japan and Italy can both produce automobiles, but Italy can produce sports cars of a higher quality and at a faster rate with greater profit, then Italy is said to have anabsolute advantagein that particular industry. On the other hand, Japan may be better served to devote limited resources and labor to other types of vehicles (such as electric cars) or another industry altogether. This may help the country enjoy an absolute advantage rather than trying to compete with Italy's efficiency.
While absolute advantage refers to the superior production capabilities of one entity versus another in a single area, comparative advantage introduces the concept ofopportunity cost.
Comparative Advantage
Comparative advantagetakes a more holistic view of production. In this case, the perspective lies in the fact that a country or business has the resources to produce a variety of goods and services rather than focus on just one product.
Theopportunity costof a given option is equal to the forfeited benefits that could have been achieved by choosing an available alternative in comparison. In general, when the profit from two products is identified, analysts would calculate the opportunity cost of choosing one option over the other.
For example, let's assume that China has enough resources to produce either smartphones or computers such that China can produce either 10 computers or 10 smartphones. Computers generate a higher profit. Theopportunity cost is the difference in value lost from producing a smartphone rather than a computer. If China earns $100 for a computer and $50 for a smartphone then the opportunity cost is $50. If China has to choose between producing computers over smartphones it will probably select computers because the chance of profit is higher.
Adam Smith is often considered to be the father of modern economics.
History of Absolute Advantage and Comparative Advantage
Scottish economist Adam Smithhelped originate the concepts of absolute and comparative advantage in his book, The Wealth of Nations.Smith argued that countries should specialize in thegoods they can produce most efficiently andtrade for any products they can't produce as well.
Smith described specialization andinternational tradeas they relate to absolute advantage. He suggested that England can produce more textiles per labor hour and Spain can produce more wine per labor hour so England should export textiles and import wine and Spain should do the opposite.
Smith made a number of basic assumptions in order for his theory to work, including:
- No change to the factors of production between different countries
- The lack of trade barriers
- An equal balance of exports and imports
- No economies of scale
British economistDavid Ricardolater built on Smith's concepts by more broadly introducing comparative advantage in the early 19thcentury. He became well-known throughout history for his musings on comparative advantage. According to Ricardo, nations can benefit from trading even if one of them has an absolute advantage in producing everything. In other words, countries must choose to diversify the goods and services they produce which requires them to consider opportunity costs.
What Is Adam Smith's Theory of Absolute Advantage?
Scottish economist Adam Smith is credited with developing the theory behind absolute and creative advantage. He wrote about them in his book, The Wealth of Nations. According to Smith, countries should focus on goods they can produce efficiently and should use trade as a way to acquire anything they aren't able to make themselves.
What Is an Example of Absolute Advantage?
There are many examples of absolute advantage, especially in the real world. For instance, Saudi Arabia's oil reserves are abundant, giving it an absolute advantage. That's one reason why it exports the commodity to other nations around the world.
How Do You Calculate Absolute Advantage?
In order to calculate absolute advantage, examine the output of the product in question between two entities. The one with the larger output has the absolute advantage. To demonstrate, let's use this example. Let's say Worker A produces 60 glue sticks and 25 large foam pads per hour and Worker B produces 20 glue sticks and 35 foam pads per hour. Worker A has the absolute advantage for glue sticks while Worker B has the absolute advantage for foam pads.
How Do You Define Comparative Advantage?
Comparative advantage is often contrasted with absolute advantage. Where absolute advantage refers to the ability of an entity to produce a greater quantity of a product or service, comparative advantage refers to the ability to produce goods and services at a lower opportunity cost compared to the competition.
What Is the Benefit of Reaching Absolute Advantage in the Production of One Good?
The benefit of reaching absolute advantage when it comes to producing a single good or service boils down to pure economics and profit. Making a product that others need (and can't produce themselves) allows you can initiate a trade relationship for goods and services that you need but can't produce yourself. This allows you to profit from the sale of your (specialized) good and still be able to enjoy the goods you import from your trading partner(s).
The Bottom Line
The idea of absolute advantage was developed by Scottish economist Adam Smith, who explained how countries can profit by only specializing in the goods and services they can produce efficiently. Smith suggested that countries can open up trade with others for products they can't make efficiently on their own. The concept is often contrasted with comparative advantage, which was explored after Smith by economists like David Ricardo. He suggested that countries produce goods and services not necessarily at a greater volume or quality but at lower opportunity costs. Although these ideas have evolved since they were first developed, the fundamental basis is still prevalent in production and international trade today.
FAQs
Comparative advantage is often contrasted with absolute advantage. Where absolute advantage refers to the ability of an entity to produce a greater quantity of a product or service, comparative advantage refers to the ability to produce goods and services at a lower opportunity cost compared to the competition.
What is the difference between absolute advantage and comparative advantage your answer? ›
Absolute Advantage: The ability of an actor to produce more of a good or service than a competitor. Comparative Advantage: The ability of an actor to produce a good or service for a lower opportunity cost than a competitor.
What is the difference between absolute and comparative advantage example? ›
Now that you have a good understanding about both types of advantages, let's reflect on the differences between the two terms. Absolute advantage is based on the advantage of cost, while comparative advantage is focused on opportunity cost. Countries can have absolute advantages in multiple products.
What is the difference between absolute and comparative advantage quizlet? ›
absolute advantage refers to the ability to produce more of a good or service using the same amount of resources and comparative advantage refers to the ability to produce a good or service at a lower opportunity cost.
Is absolute advantage or comparative advantage more important for trade explain your answer? ›
A country that has an absolute advantage in producing all goods still stands to benefit from trade with other countries, since the basis of the gains for trade is comparative advantage, not absolute advantage. It is not possible for an individual or country to have a comparative advantage in all goods.
What is the difference between absolute and comparative theory? ›
In absolute cost advantage theory, trade is not considered mutual and reciprocal. In contrast, in comparative advantage theory, trade between the countries is considered as mutual and reciprocal. Cost is the primary factor in absolute advantage.
What is an example of an absolute advantage? ›
Geography: A country's location can provide proximity to natural resources, which can give it an absolute advantage over other countries. For example, one nation may produce oil more quickly and effectively than another country can, giving the former an absolute advantage.
What are 2 examples of comparative advantage? ›
For example Ireland has a comparative advantage in cheese and butter due to climate and a large amount of land suitable for dairy cows. China has a comparative advantage in electronics because it has an abundance of labor.
What is comparative advantage example and answers? ›
For example, if a country is skilled at making both cheese and chocolate, they may determine how much labor goes into producing each good. If it takes one hour of labor to produce 10 units of cheese and one of of labor to produce 20 units of chocolate, then this country has a comparative advantage in making chocolate.
What is comparative advantage and example? ›
Comparative advantage is what you do best while also giving up the least. For example, if you're a great plumber and a great babysitter, your comparative advantage is plumbing.
Competitive advantage refers to a company's ability to outperform its competitors. Comparative advantage is how a business lowers costs to gain leverage against its competitors.
What is the meaning of absolute advantage? ›
Absolute advantage is the ability of an individual, company, region, or country to produce a greater quantity of a good or service with the same quantity of inputs per unit of time, or to produce the same quantity of a good or service per unit of time using a lesser quantity of inputs, than its competitors.
What is the difference between absolute and comparative advantage Quora? ›
Originally Answered: What is the difference between absolute advantage and comparative advantage ? Absolute advantage means that you can produce more of something than someone else. Comparative advantage means that you can produce something more cheaply than someone else.
How do you determine absolute advantage? ›
To calculate absolute advantage, look at the larger of the numbers for each product. One worker in Canada can produce more lumber (40 tons versus 30 tons), so Canada has the absolute advantage in lumber. One worker in Venezuela can produce 60 barrels of oil compared to a worker in Canada who can produce only 20.
What are the benefits of absolute advantage? ›
The benefit of the theory of absolute advantage is that it can help countries maximize their productivity and efficiency. If one country has an absolute advantage over every other when it comes to producing one product, having that nation focus all of its resources on creating that product benefits the whole planet.
What are the benefits of comparative advantage? ›
The benefit of comparative advantage is the ability to produce a good or service at a lower opportunity cost. A comparative advantage gives companies the ability to sell goods and services at reduced prices than their competitors, gaining stronger sales margins and greater profitability.
What is the similarity between absolute advantage and comparative advantage? ›
Key Takeaways
Absolute advantage is when a producer can produce a good or service in greater quantity for the same cost, or the same quantity at a lower cost, than other producers. Comparative advantage, on the other hand, takes into account the opportunity cost in order to achieve absolute advantage.
What do both absolute and comparative advantage theories assume? ›
The theories of comparative and absolute advantage assume that specialization in the production of one particular good results in efficiency gains.
What are the sources of comparative advantage? ›
What are the Sources of Comparative Advantage? Comparative advantage is determined by a country's resources, that is the land, labour, capital and enterprise.
What is the difference between comparative and absolute advantage in economics? ›
What Is Absolute Advantage Vs Comparative Advantage? Absolute advantage is the ability to produce an increased number of goods and services at better quality than competitors. In contrast, Comparative Advantage signifies the ability to manufacture goods or services at a relatively lower opportunity cost.
Country 2 can gain comparative advantage by producing their pants and shoes at a lower cost. Also by using less resources to produce their goods. A person with comparative advantage produces something at a lower cost while absolute advantage is being better at producing something than someone else.
Which of the following is a comparative advantage? ›
Comparative advantage includes inherited resources, such as labor, climate, arable land, and petroleum reserves.
What is a real life example of comparative advantage? ›
A contemporary example: China's comparative advantage with the United States is in the form of cheap labor. Chinese workers produce simple consumer goods at a much lower opportunity cost. The United States' comparative advantage is in specialized, capital-intensive labor.
What is an example of comparative advantage of an organization? ›
For example, a firm that manufactures a product in China may have lower labor costs than a company that manufactures in the U.S., so it can offer an equal product at a lower price. In the context of international trade economics, opportunity cost determines comparative advantages.
What is a comparative advantage quizlet? ›
Comparative advantage is the ability of a firm or individual to produce goods and/or services at a lower opportunity cost than other firms or individuals. A comparative advantage gives a company the ability to sell goods and services at a lower price than its competitors and realize stronger sales margins.
What are the 3 types of competitive advantage? ›
The three main types of competitive advantages are differentiation, cost advantages, and focus advantages.
What is the comparative advantage argument? ›
Popularized by David Ricardo, comparative advantage argues that free trade works even if one partner in a deal holds absolute advantage in all areas of production – that is, one partner makes products cheaper, better and faster than its trading partner.
What are the 4 competitive advantages? ›
The four primary methods of gaining a competitive advantage are cost leadership, differentiation, defensive strategies and strategic alliances.
Is absolute advantage or comparative advantage more? ›
The comparative advantage concept is more effective in helping countries decide resource allocation, production, and trade than an absolute advantage. Trade transactions between countries having the absolute advantage are not mutually beneficial.
Can you have absolute and comparative advantage? ›
Yes, it is possible for a country to have both an absolute and comparative advantage. However, this would only be possible with one good because: A comparative advantage only exists when a country can produce a good at a lower opportunity cost when compared to alternatives and other countries.
Yes, it is possible, but not to have an absolute advantage because comparative advantage is defined by what you have to give up to produce a good. If the opportunity cost of production is low, a country will still have a comparative advantage even when at an absolute disadvantage.
What does absolute advantage depend on? ›
An absolute advantage is achieved through low-cost production. In other words, it refers to an individual, company, or country that can produce at a lower marginal cost. Such an advantage is established when (compared to competitors): Fewer materials are used to produce a product.
What are the problems of comparative advantage? ›
Limitation of the theory of comparative advantage
- Transport costs may outweigh any comparative advantage.
- Increased specialisation may lead to diseconomies of scale.
- Governments may restrict trade.
Comparative advantage enables both sides to benefit from trade. This is because each side accesses goods at a lower price than its opportunity cost. On the other hand, producers could produce more goods using fewer resources if they were in a situation of absolute advantage.
What are the advantages and disadvantages of comparative advantage? ›
Advantages And Disadvantages
| Advantages | Disadvantages |
|---|
| Lower opportunity costs | Limitations on trade conducted |
| Higher profit margins | Illusion of savings |
| Access to more customers | Difficult to find skilled labor |
| Improved efficiency | Assumptions fail to succeed. |
2 more rowsCompetitive advantage refers to a company's ability to outperform its competitors. Comparative advantage is how a business lowers costs to gain leverage against its competitors.
What is an example of a comparative advantage? ›
For example, if a country is skilled at making both cheese and chocolate, they may determine how much labor goes into producing each good. If it takes one hour of labor to produce 10 units of cheese and one of of labor to produce 20 units of chocolate, then this country has a comparative advantage in making chocolate.
What is an absolute advantage quizlet? ›
Absolute advantage is the ability of a country, individual, company or region to produce a good or service at a lower cost per unit than the cost at which any other entity that good or service.
What is the difference between absolute advantage and comparative advantage and opportunity cost? ›
Absolute advantage is when one country produces better quality goods at lower cost than another, whereas comparative advantage is when one country is able to produce goods at a lesser opportunity cost than the other.
What is the advantage of comparative advantage? ›
The benefit of comparative advantage is the ability to produce a good or service at a lower opportunity cost. A comparative advantage gives companies the ability to sell goods and services at reduced prices than their competitors, gaining stronger sales margins and greater profitability.
To calculate absolute advantage, look at the larger of the numbers for each product. One worker in Canada can produce more lumber (40 tons versus 30 tons), so Canada has the absolute advantage in lumber. One worker in Venezuela can produce 60 barrels of oil compared to a worker in Canada who can produce only 20.
Why is absolute advantage useful? ›
The benefit of the theory of absolute advantage is that it can help countries maximize their productivity and efficiency. If one country has an absolute advantage over every other when it comes to producing one product, having that nation focus all of its resources on creating that product benefits the whole planet.
Why do people have absolute advantage? ›
An absolute advantage is achieved through low-cost production. In other words, it refers to an individual, company, or country that can produce at a lower marginal cost. Such an advantage is established when (compared to competitors): Fewer materials are used to produce a product.
What does the comparative advantage refer to? ›
Comparative advantage refers to the ability to produce goods and services at a lower opportunity cost, not necessarily at a greater volume or quality.
