Absolute Advantage

Absolute Advantage

What is absolute advantage?

The absolute advantage is the ability of an individual, a company, a region or a country to produce a greater quantity of a good or service with the same quantity of inputs per unit of time, or producing the same amount of a good or service per unit of time using a lesser amount of inputs, than another entity that produces the same good or service. An entity with an absolute advantage can produce a product or service at a lower absolute unit cost using fewer inputs or a more efficient process than another entity producing the same good or service.

Key points to remember

  • The absolute advantage is when a producer can produce a good or service in larger quantities for the same cost, or the same quantity at a lower cost, than other producers.
  • Absolute advantage can be the basis for significant gains in trade between producers of different goods with different absolute advantages.
  • Through specialization, the division of labor and trade, producers with different absolute advantages can always gain from producing in isolation.
  • Absolute advantage is linked to comparative advantage, which can open up even greater possibilities for division of labor and commercial gain.

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Basic concept of absolute advantage

Understanding the absolute advantage

The concept of absolute advantage was developed by Adam Smith in his book Wealth of Nations show how countries can profit from trade by specializing in the production and export of the goods they can produce more efficiently than other countries. Countries with an absolute advantage may decide to specialize in the production and sale of a specific good or service and use the funds that this good or service generates to buy goods and services in other countries. other countries.

According to Smith’s argument, specializing in the products for which they each have an absolute advantage, and then marketing products, can improve the situation of all countries, provided they each have at least one product for which they hold. an absolute advantage over other nations.

General example of absolute advantage

Consider the two hypothetical countries, Atlantica and Krasnovia, with equivalent populations and resource resources, which each produce two products, Guns and Bacon. Each year, Atlantica can produce either 12 cannons or 6 bacon plates, while Krasnovia can produce either 6 cannons or 12 bacon plates. Each country needs a minimum of 4 guns and 4 bacon plates to survive. In a state of autarky, produce only for their own needs, Atlantica can spend ⅓ of the year making pistols and ⅔ making bacon for a total of 4 pistols and 4 bacon plates. Krasnovia can spend ⅓ of the year making bacon and ⅔ making pistols to produce 4 pistols and 4 bacon plates. That leaves each country on the brink of survival, with barely enough guns and bacon to go around. However, not that Atlantica has an absolute advantage in the production of firearms, and Krasnovia has an absolute advantage in the production of bacon.

The absolute advantage also explains why it makes sense for individuals, businesses and countries to trade. Since each has advantages in the production of certain goods and services, both entities can benefit from trade.

If each country were to specialize in its absolute advantage, Atlantica could manufacture 12 rifles and no bacon, while Krasnovia would not manufacture rifles and 12 bacon plates. By specializing, the two countries share the tasks of their work. If they then trade 6 guns for 6 bacon plates, each country would then have 6 of each. The two countries would now be better off than before, because each would have 6 pistols and 6 bacons, against 4 of each good they could produce themselves.

This mutual gain in trade is the basis of Adam Smith’s argument that specialization, division of labor, and subsequent trade lead to an overall increase in wealth from which everyone can benefit. This, according to Smith, was the root cause of the eponym Wealth of Nations.

Absolute and comparative advantage

Absolute advantage can be compared to comparative advantage, that is, when a producer has a lower opportunity cost to produce a good or service than another producer. Absolute advantage leads to unambiguous gains through specialization and trade only in cases where each producer has an absolute advantage in the production of certain goods. If a producer has no absolute advantage, Adam Smith’s argument would not necessarily apply. However, the producer and its trading partners may still be able to realize commercial gains if they could specialize based on their respective comparative advantages.

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