Absolute Advantage

The ability of a person, company, or nation to produce more of a good or service than its opponents.

 

It refers to the ability of a person, company, or nation to produce more of a good or service than its opponents.

Absolute advantage in a good or service is a result of the industry's ability to produce it at a lower cost than its rivals. It is done in one of the following ways:

  • Producing the same amount of a good or service with a lower cost per unit, using fewer inputs.
  • Creating more of a good or service using the same amount of inputs.

Producing efficiently and having lower costs of production occurs when the individual or nation:

  • Utilizes fewer resources for production
  • Uses cheaper resources (land and capital) for production
  • Utilizes cheaper workers (lower wages) for production
  • Completes production in fewer hours

Sources for these upper hands in production include 

1. Absolute Cost:

  • Specialization and producing more help reduce costs

By specializing in one activity, workers train and excel in that specific aspect of production, which enhances their productivity. Increasing productivity per unit of labor helps reduce costs and increase output.

2. Natural:

  • Suitable climate and abundant access to natural resources

Sometimes specific climatic conditions are needed to grow or produce certain goods in great quantities. An example is a coffee, which grows in tropical climates, like Colombia.  

3. Acquired:

  • Technological advances and skills

As technological developments arise, higher skills are needed, like the ability to operate various machines and computers. So, economies with an abundance of higher-skilled workers have an advantage over others.

Understanding what absolute advantage tells us

Scottish economist, Adam Smith, was the first to introduce this concept in his famous book The Wealth of Nations in 1776. Smith published these ideas and made significant contributions to international trade. 

Smith discusses the importance of specialization and the efficient division of labor. His work revolves around the idea that entities specialize in producing the good in which they have an absolute advantage. 

Specialization helps countries engage in free trade in a way where they sell the commodities that they are the best at producing.  

They can buy other goods and services from various nations worldwide and focus on making the goods they have an advantage in instead of producing everything. Thus, it allows for the efficient use of resources to maximize wealth. 

Smith argued that keeping absolute advantage in mind would help countries gain through open free trade in the global market. So, they would allocate resources to the making and exporting of the goods they produced most efficiently and import other goods. 

In this way, both players can gain from the trade. 

In other words, trade makes all entities better off if each country has an absolute advantage in at least one commodity over its competitors.

Absolute advantage is determined by finding the largest output value for each product produced by each country in comparison. 

Examples 

Example 1

Consider two hypothetical countries, Country A and Country B, and assume they have an equal number of resources at their disposal. Each country produces two goods – dates and oil – with the following production possibilities:

Example #1
Quantity of goods produced by each country
CountryOilDates
Country A750 barrels75 tons
Country B500 barrels 100 tons

 

According to the above table:

  • Country A can produce either 75 tons of dates or 750 barrels of oil 
  • Country B can produce either 100 tons of dates or 500 barrels of oil. 
  • Looking at the values, Country A can produce more oil than Country B (750 barrels compared to 500). So, Country A has the absolute advantage in producing oil. 
  • Meanwhile, Country B can produce more dates than Country A (100 tons compared to 75). So, Country B has the absolute advantage in making dates. 

Example 2

Hypothetically consider an economy with two countries, Country A and B, and two goods. The hours of labor required to produce one unit of a good is

Example #2
Hours of labor work necessary to produce a single unit
CountryComputerClothing
A7090
B11080

From the table above 

  • Country A can produce one computer after spending 70 hours of labor, while Country B takes 110 hours to produce the same. Therefore, Country A has the absolute advantage in producing computers as it utilizes fewer hours of labor. 
  • On the other hand, Country A can produce one unit of clothing after 90 hours, which is less efficient than Country B, which needs 80 hours of labor to perform the same task. So, Country B has the advantage in producing clothing. 

In autarky, economies do not engage in trade with one another and produce everything themselves. Here each country produces one unit of clothing and computer each after putting in the specified hours of labor.

If Country A, which specializes in making computers, allocates all of its labor to that activity, that would be 70 hours added to the 90 hours reallocated from clothing. So, Country A would produce (70+90)/70 = 2.29 units

If Country B, which specializes in making clothing, allocates all of its labor to that activity, that would mean they have 110 hours additional to 80 hours after reallocating from computers. So, Country B would produce (110+80)/80 = 2.38 units

After specializing, each country now produces more of the product than they did before. This creates the opportunity to trade with each other and gain from it. 

Real-world examples of countries with an advantage in a particular good

Saudi Arabia, one of the countries in the Gulf Cooperation Council (GCC), has an absolute advantage in extracting oil, attributed to the country's strategic location and access to oil reserves. Oil production accounts for a significant portion of the country's revenue. 

In the absence of trade, other countries, such as those in the Western part of the world, would have to resort to more costly methods, like offshore drilling. 

Another real-world example is Colombia, where the temperature, rainfall, and soil facilitate coffee production. Other countries, like colder ones, may not be able to produce as much coffee, or even at all. 

If either of these two countries tried to produce the other product, the production cost would be relatively high, especially when compared to the other. Thus, it would lead to a waste of talent, resources, and effort. This will diminish their productivity and encourage them to trade for those goods instead.

How does it differ from comparative advantage?

Absolute advantage looks at producing more of a good or service with fewer resources or through a more efficient method than rival players.

Meanwhile, comparative advantage refers to producing at a lower 

 than competitors. So, the comparative advantage does not necessarily mean producing more or differing quality.

For instance, using the same scenario from Example 1:

Example #1
Quantity of goods produced by each country
CountryOilDates
Country A750 barrels75 tons
Country B500 barrels 100 tons

The comparative advantage can be found by comparing the opportunity costs in terms of the other good:

Oil: 

Country A: 75/750 = 1/10 tons of dates 

Country B: 100/500 = ⅕ tons of dates 

1/10 < ⅕ → Country A has the lower opportunity cost → comparative advantage in oil

Dates: 

Country A: 750/75 = 10 barrels of oil

Country B: 500/100 = 5 barrels of oil 

5 < 10 → Country B has the lower opportunity cost → comparative advantage in dates

So, Country A has to forego fewer tons of dates to make more oil, and Country B has to sacrifice fewer barrels of oil to make more dates. 

Disadvantages/Limitations

Some assumptions explain the theory behind absolute advantage, but these are not always valid in real-world economies. These are outlined below:

1. Free Trade:

  • As opposed to the economic models, completely open and free trade between countries rarely exists. Tariffs, quotas, and other protectionist barriers are often imposed on trade between countries. 
  • These protectionist barriers may make trade more expensive and make it more efficient for a country to produce a certain good domestically. So, it restricts the free movement of goods, and truly free trade becomes rare. 

2. Demand:

  • Focusing on producing the product that a country has the advantage in would only be beneficial if it is needed and demanded by the people.  

3. Bilateral trade:

  • To simplify the model, the theory relies on the assumption that trade occurs between two nations with only two products. 
  • However, trade between real-world countries is often multilateral and more complex, where they trade more than two products with several partners.

Key Takeaways

  • Absolute advantage is a concept developed by Adam Smith and is used to explain the ability to make a product at a lower cost than competitors or make more using the same resources. 
  • This concept is different from comparative advantage, which relies on lowered opportunity costs. 
  • The theory tells us that if a country specializes in the production of their absolute advantage and allocates labor towards that activity and then participates in trade, both parties would benefit more than if they produced those goods alone.
Accounting Foundations Course

Everything You Need To Build Your Accounting Skills

To Help You Thrive in the Most Flexible Job in the World.

Learn More

Researched and authored by Laila Al-Eisawi | LinkedIn

Reviewed and Edited by Parul Gupta | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources: