Absolute vs. Comparative Advantage: An Overview
Absolute and comparative advantage are two concepts in economics and international trade that influence how and why nations and businesses devote resources toproducing particular goods and services.
Absolute advantage means one entity can manufacture a product at a higher quality and a faster rate for a greater profit than another competing business or country. Conversely, comparative advantage considers the opportunity costs when manufacturing 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 superiority of a country or business to produce a particular good.
- Comparative advantage introduces opportunity cost as a factor for analysis in choosing between production diversification.
Absolute Advantage
The abilities of companies and nations to produce goods efficiently are the basis for absolute advantage. Absolute advantage is accomplished by creating the good or service at a lower absolute cost per unit using fewer inputs, or a more efficient process. Countries tend to avoid producing goods and services with little to no demand.
Absolute advantage is recognized with lower labor costs, access to a supply of resources, and a large pool of available capital. For example, Japan and Italy both produce automobiles. If Italy can manufacture higher quality sports cars with greater profit, then Italy is said to have an absolute advantage in that industry. On the other hand, Japan may devote limited resources and labor to electric cars or another industry to enjoy an absolute advantage rather than trying to compete with Italy's efficiency.
Comparative Advantage
When a country or business has multiple resources to produce various goods and services rather than focus on just one product, it may look for a comparative advantage. Comparative advantage explains why companies, countries, or individuals benefit from trade. The opportunity cost of a given option is equal to the forfeited benefits achieved by choosing an available alternative in comparison.
Suppose China has the resources to produce smartphones and computers and can manufacture either 10 million computers or 10 million smartphones. If computers generate a higher profit, the opportunity 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 $500 million. China will probably select computers because the chance of profit is higher.
Important
Opportunity cost is the forgone benefit that would have been derived from an option other than the one chosen.
Economic Theory
Scottish economist Adam Smith helped originate the concepts of absolute and comparative advantage in his book, The Wealth of Nations. Smith argued that countries should specialize in the goods they can produce most efficiently and trade for any products they can't produce as well.
Smith touted the marriage of specialization and international trade as they relate to absolute advantage. He suggested that England could produce more textiles per labor hour and Spain could produce more wine per labor hour, so England should export textiles and import wine, and Spain do the opposite.
Smith's theory assumes that the factors of production between countries don't change, there are no barriers to trade, and exports and imports are equal. British economist David Ricardo built on Smith's concepts by more broadly introducing comparative advantage in the early 19th century. He became well-known for his musings on comparative advantage. According to Ricardo, nations can benefit from trading even if one has an absolute advantage in producing everything.
Why Did the Economist Adam Smith Promote the Benefits of Trade?
Scottish economist Adam Smith is credited with developing the theories of absolute and creative advantage in his book, The Wealth of Nations. According to Smith, countries should focus on goods they can produce efficiently and use trade to acquire anything they can't make themselves. The mutual gain from trade forms the basis of Smith’s argument that specialization, the division of labor, and subsequent trade lead to prosperity for all.
What Is an Example of Absolute Advantage?
Saudi Arabia's oil reserves are abundant, giving it an absolute advantage. That's one reason it exports the commodity to other nations worldwide.
What Is the Benefit of Reaching Absolute Advantage in the Production of One Good?
The benefit of reaching absolute advantage when producing a single good or service is economics and profit. Making a product that others need and can't produce allows a company or country to initiate a trade relationship for goods and services it needs but can't produce. This will enable the company or country to profit from the specialized goods and import from the trading partner.
The Bottom Line
Scottish economist Adam Smith explained how countries can profit by only specializing in the goods and services they can produce and trade with others for products they can't make efficiently. The concept is often contrasted with comparative advantage in that countries produce goods and services not necessarily at a greater volume or quality at lower opportunity costs.