Absolute Advantage Vs Comparative Advantage
Absolute Advantage Vs Comparative Advantage: Absolute advantage – Ability to produce a higher portion of goods and services using the same amount of output. Comparative advantage – Nation’s ability to generate a good or service at a lower opportunity cost than other nations.
Meaning of Absolute and Comparative Advantage
What is absolute advantage?
Absolute advantage means the ability to produce a higher portion of goods and services using the same amount of output or using less amount of inputs to produce the same quantity of goods and services by an individual, company, region or country than its rivals.
Theory of absolute advantage
The theory of absolute advantage says that there are only two countries and these countries trade with each other when they have an absolute advantage in producing products. As an example, when country X has an absolute advantage in producing wheat and country X exports its wheat to country Y by importing cloth from country Y that country Y has an absolute advantage in producing cloth.
Who is the founder of the absolute advantage theory?
The famous economist “Adam Smith” has developed the theory of absolute advantage in his book “The Wealth of Nations” which was published in the 18th century. In this book, he explains how countries can gain from international trade by specializing in producing and exporting goods.
Smith stated that as long as each country has at least one good in which it has a clear advantage over other countries, specializing in the products in which they each have an absolute advantage and then selling the goods can benefit all countries.
According to Smith, based on specialization, subsequent trade and division of labour, countries can gain mutual benefits from trade. This, Smith believed, was the root source of the eponymous “Wealth of Nations.”
You may be interested in to read more “What is Absolute Advantage? – With Examples”
What Is Comparative Advantage?
Comparative advantage means a nation’s ability to generate a good or service at a lower opportunity cost than other nations. According to the comparative advantage theory, a country may be not the best at producing a good or service but sometimes it may be able to produce this good or service at a lower opportunity cost than other nations.
But the comparative advantage is not only limited to explaining the international trade between countries, it also can explain how individuals and companies get benefits from the trade.
Theory of comparative advantage
The theory of comparative advantage can be identified as one of the most important economics and one of the fundamental principles of international trade.
The main understanding of the theory of comparative advantage depends on the opportunity cost.
Opportunity cost can be defined as the value of the losing best option as a result of you selecting an option. In other words, opportunity cost means when we make a decision, the value of the next best option that we lost or we have to give up.
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Who is the father of comparative advantage?
At the first time, the theory of comparative advantage was introduced by the famous English political economist, David Ricardo in his 1817 book “On the Principles of Political Economy and Taxation”. Ricardo’s mentor, James Mill, originated this analysis.
High income countries can produce all the goods at a lower cost than low-income countries. Because high income countries abundant with the skilled employees, new technologies, advanced equipment, up-to-data production process.
So, is there any opportunity to still gains from international trade? Yes.
David Ricardo stated that still countries can get mutual benefits, although one country has an absolute advantage in all goods.
For that each country should have comparative advantage to produce one good.
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How to calculate comparative advantage?
Definition and examples of comparative advantage
Comparative advantage vs competitive advantage
Similarities between Absolute Advantage and Comparative Advantage
Before discussing about the differences between absolute advantage and comparative advantage, it is very important to discuss the similarities between absolute advantage and comparative advantage. Because both absolute advantage and comparative advantage are very important concepts when engaging the international trade. Let’s discuss these similarities.
1. Both concepts of absolute advantage and comparative advantage focus to increase output. Absolute advantage try to increase domestic production more efficiently. Comparative advantage also focuses to increase the output level by combining both domestic production and imports.
2. Absolute advantage and comparative advantage can be applied not only for nations but also to individuals and business organizations. Because both concepts emphasize the importance of the maximize the benefits of scarce resources.
3.Both concepts of absolute advantage and comparative advantage encourage the free trade. Before these concepts, mercantilism was accepted by the economists. Mercantilism is the premier body of thought on international trade, was developed in Europe during the 17th and 18th centuries. According to mercantilist writers, promoting a favorable balance of trade is the main goal of international trade. The term “favorable balance of trade” in this context refers to an excess of trade between the nations, where the value of products exported exceeds the value of goods imported. Adam Smith and David Ricardo opposed the philosophy of mercantilism and introduced the theories of absolute advantage and comparative advantage, respectively. These theories depend on the principles of free trade and specialization when generating such products where inputs are sufficient.
Difference Between Absolute Advantage Vs Comparative Advantage
Let’s discuss the key differences between absolute vs comparative advantage.
1. Definition: Absolute advantage means a country’s ability to produce specific goods effectively and efficiently at a lower marginal cost. But comparative advantage emphasizes the importance of producing specific goods at lower marginal cost and lower opportunity cost.
2. Basic idea: The concept of absolute advantage is based on producing a specific good at a lower marginal cost. However, the concept of comparative advantage is based on producing a specific good at a lower opportunity cost than the competitors.
3. Cost of production: Countries with an absolute advantage of producing a good focus on maximizing production with the same available resources. For example, Japan can produce more efficiently computers than cameras. So, Japan focuses to produce more computers. Here cost is the primary factor that we consider (not the opportunity cost). However, Countries with comparative advantage take into account the production of multiple goods in the country while deciding the production of a specific good and resource allocation.
4. Trade benefits: When traders make decisions based on absolute advantage, they are not mutually beneficial in nature. When traders make decisions based on comparative advantage, they are mutually beneficial in nature.
5. Founders: The famous economist “Adam Smith” has developed the theory of absolute advantage in his book “The Wealth of Nations” which was published in the 18th century. In this book, he explains how countries can gain from international trade by specializing in producing and exporting goods. At the first time, the theory of comparative advantage was introduced by the famous English political economist, David Ricardo in his 1817 book “On the Principles of Political Economy and Taxation”. Ricardo’s mentor, James Mill, originated this analysis.
6. Resource allocation: Resource allocation is not relevant to the absolute advantage so the opportunity cost is not considered. But resource allocation is relevant for the comparative advantage so the opportunity cost is considered.
Absolute vs Comparative Advantage table
Absolute Advantage vs Comparative Advantage: Which is Better?
The reality is that the entire idea of comparative advantage is the real driver behind international trade. Even if a nation lacks the resources to produce or manufacture something with an absolute advantage, it can nonetheless participate in international trade and profit from it because to the notion of comparative advantage.
Absolute Advantage Vs Comparative Advantage Example
Assume that Brazil and USA can produce coffee and breads. Following table 1 shows how many Kilograms of coffee or loafs of bread can be produced by each country using one hour of labour.
Calculate the absolute advantage of both products
According to the above example, the USA can produce 40 bread loafs within a labour hour while Brazil can produce 8 bread loafs within a labour hour. So, USA can produce more bread loafs than the Brazil within a labour hour. In other words, USA is more specialized to produce Bread loafs than the Brazil. That means the USA has the absolute advantage of producing Bread.
According to the above example, the USA can produce 20 kg of coffee within a labour hour while Brazil can produce 12 kg of coffee within a labour hour. So, the USA can produce more coffee than Brazil within a labour hour. In other words, USA is more specialized to produce Bread coffee than Brazil. That means the USA has the absolute advantage of producing coffee.
Calculate the comparative advantage of both products
Let’s check the comparative advantage of producing bread and coffee.
The opportunity cost of producing a bread loaf
The opportunity cost of producing a bread = Number of coffee kg production within a labour hour/ Number of bread loafs production within a labour hour
USA = 20 / 40 = 0.5kg coffee
Brazil = 12 / 8 = 1.5 coffee
The opportunity cost of producing a 1kg coffee
The opportunity cost of producing a 1kg of coffee = Number of bread loaf production within a labour hour/ Number of coffee kg produced within a labour hour
USA = 40 / 20 = 2 bread loafs
Brazil = 8 / 12 = 0.67 bread loafs
The opportunity cost of producing bread and coffee can be summarized as follows.
A country has a comparative advantage when it can produce a particular good at a lower opportunity cost than another country. According to the above table, USA has a lower opportunity cost of producing bread when compared with Brazil. Brazil has a lower opportunity cost of producing coffee when compared with USA.
So, when engaging in international trade, USA should produce more and export the bread by importing coffee from Brazil. Brazil should produce more and export the coffee by importing breads from USA.