Absolute Advantage

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absolute advantage

In economics,absolute advantages refers to the ability of a party (an individual, firm, or country) to produce more of a good or service than competitors, using the same amount of resources.A party has an absolute advantage when using the same input as another party, it can produce a greater output.Since absolute advantage is determined by a simple comparison of labor productivities, it is possible for a party to have no absolute advantage in anything.It can be contrasted with the concept of comparative advantage which refers to the ability to produce a particular good at a lower opportunity cost.

Adam Smith developed the principle of absolute advantage. The economist Paul Craig Roberts notes that the comparative advantage principles developed by David Ricardo do not hold where the factors of production are internationally mobile. Limitations to the theory may exist if there are single kind of utility. The very fact that people want food and shelter already indicates that multiple utilities are present in human desire. The moment the model expands from one good to multiple goods, the absolute may turn to a comparative advantage. However, global labor arbitrage, where one country exploits the cheap labor of another, would be a case of absolute advantage that is not mutually beneficial.

Generally, in international trade, countries export goods and services for which they have an absolute advantage in and import goods and services in which another country has the absolute advantage. According to the theory of absolute advantage, a country that has no absolute advantage in any product or service, then no trade will occur. The two concepts have applications outside international trade, though this is where they are most commonly used. Suppose that two castaways on a desert island gather both fruit and grain, which they then share equally between them. Suppose that Castaway A can gather more fruit per hour than Castaway B, and therefore has an absolute advantage in this good. Nonetheless, it may well make sense for A to leave some fruit-gathering to B. This is because it is possible that B gathers fruit slightly slower than A, but gathers grain extremely slowly. One needs to look at comparative advantage rather than absolute advantage, to discover how A and B can each best allocate their effort. If A's initial advantage over B in grain-gathering is greater than his or her advantage in fruit-gathering, then fruit-effort should be transferred from A to B, to the point where A's comparative advantages in the two goods are equal. Thus it may be rational for fruit to flow from B to A, despite A's absolute advantage.

The concept of absolute advantage is generally attributed to Adam Smith for his 1776 publication An Inquiry into the Nature and Causes of 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. Absolute advantage does not take into account opportunity cost.

While there are possible gains from trade with absolute advantage, comparative advantage extends the range of possible mutually beneficial exchanges. In other words it is not necessary to have an absolute advantage to gain from trade, only a comparative advantage.

Origin of the Theory

Examples Example 1

Party A can produce 5 widgets per hour with 3 employees.

example 1

Party B can produce 10 widgets per hour with 3 employees.
Assuming that the employees of both parties are paid equally, Party B has an absolute advantage over Party A in producing widgets per hour. This is because Party B can produce twice as many widgets as Party A can with the same number of employees.

Example 2

Country A can produce 1000 parts per hour with 200 workers.

example 2

Country B can produce 2500 parts per hour with 200 workers.
Country C can produce 10000 parts per hour with 200 workers.
Considering that labor and material costs are all equivalent, Country C has the absolute advantage over both Country B and Country A because it can produce the most parts per hour at the same cost as other nations. Country B has an absolute advantage over Country A because it can produce more parts per hour with the same number of employees. Country A has no absolute advantage because it can't produce more goods than either Country B or Country C given the same input.

Example 3

You and your friends decided to help with fundraising for a local charity group by printing t-shirts and making birdhouses.

Scenario 1: One of your friends, Gina, can print 5 t-shirts or build 3 birdhouses an hour. Your other friend, Mike, can print 3 t-shirts an hour or build 2 birdhouses an hour. Because your friend Gina is more productive at printing t-shirts and building birdhouses compared to Mike, she has a comparative advantage in both printing t-shirts and building birdhouses.
Scenario 2: Suppose Gina wasn't as agile with the hammer and could only make 1 birdhouse an hour, but she took a sewing class and could print 10 t-shirts an hour. Mike on the other hand takes woodworking and so he can build 5 birdhouses an hour, but he doesn't know the first thing about making t-shirts so he can only print 2 t-shirts an hour. While Gina would have the absolute advantage in printing shirts, Mike would have an absolute advantage in building birdhouses.