Absolute Advantage

What is an Absolute Advantage?

Definition: An absolute advantage is a country or company’s ability to produce a product or service at the lowest cost compared with its competitors. In other words, it’s a company’s manufacturing processes, intellect, or any number of things that allows a company to produce products much more cost efficiently than other companies.

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 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 cost per unit using a smaller number of inputs or a more efficient process than another entity producing the same good or service.

This concept was introduced by Adam Smith, and it may also refer to a person’s ability to perform a task better than any other.

Origin of the Theory

The concept of absolute advantage is generally attributed to Adam Smith for his 1776 publication The Wealth of Nations in which he countered mercantilist ideas. Smith argued that it was impossible for all nations to become rich simultaneously by following mercantilism because the export of one nation is another nation’s import and instead stated that all nations would gain simultaneously if they practiced free trade and specialized in accordance with their absolute advantage. Smith also stated that the wealth of nations depends upon the goods and services available to their citizens, rather than their gold reserves.

Because Smith only focused on comparing labor productivities to determine absolute advantage, he did not develop the concept of comparative advantage. While there are possible gains from trade with absolute advantage, the gains may not be mutually beneficial. Comparative advantage focuses on the range of possible mutually beneficial exchanges.

What Does Absolute Advantage Mean?

The absolute advantage is used to compare a nation, firm, or individual’s efficiency to another. A country with an absolute advantage seeks to export the product or the service that it can produce at the lowest cost and to import the products or services that another country produces at the lowest cost. In doing so, countries are using their natural resources, thus lowering the production costs.

Furthermore, production costs are different between countries. The country with the lowest production costs at any level of labor typically has an advantage as well.

Example

China and Italy are involved in international trade. China produces textile at a lower cost than any other country because of its loose labor laws. Italy, on the other hand, produces wine at a lower cost than any other country because of its vast vineyards and climate.

Assuming that a working hour is equal to a monetary unit in both countries, then the prices for the production of textile in China and Italy are $100 and $150, respectively, whereas and the prices for the production of wine in China and Italy are $130 and $70, respectively.

Each country seeks to export the product that it produces at the lowest cost and to import the product that the other country produces at the lowest cost. Obviously, China seeks to export textile and import wine, whereas Italy seeks to export wine and import textile. The absolute advantage for each country is in the product that it produces at the lowest labor and production cost. In this case, China’s is in textile and Italy’s is in wine.

Companies work the same way, producing and selling what is most advantageous to them while purchasing things that they can’t make efficiently.

Absolute Advantage and Comparative Advantage

Absolute advantage can be contrasted to comparative advantage, which is when a producer has a lower opportunity cost to produce a good or service than another producer. Absolute advantage leads to unambiguous gains from specialization and trade only in cases where each producer has an absolute advantage in producing some good. If a producer lacks any absolute advantage then Adam Smith’s argument would not necessarily apply. However, the producer and its trading partners might still be able to realized gains from trade if they can specialize based on their respective comparative advantages instead.

Summary by Absolute Advantage

  • Absolute advantage is when a producer can produce a good or service in greater quantity for the same cost, or the same quantity at lower cost, than other producers.
  • Absolute advantage can be the basis for large gains from trade between producers of different goods with different absolute advantages.
  • By specialization, division of labor, and trade, producers with different absolute advantages can always gain over producing in isolation.
  • Absolute advantage is related to comparative advantage, which can open up even more widespread opportunities for the division of labor and gains from trade.

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