Absolute advantage

In economics, the principle of absolute advantage refers to the ability of a party (an individual, or firm, or country) to produce a greater quantity of a good, product, or service than competitors, using the same amount of resources. Adam Smith first described the principle of absolute advantage in the context of international trade, using labor as the only input. Since absolute advantage is determined by a simple comparison of labor productiveness, it is possible for a party to have no absolute advantage in anything;[1] in that case, according to the theory of absolute advantage, no trade will occur with the other party.[2]

Origin of the theory

The main 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.[1][3] 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.[1] Smith also stated that the wealth of nations depends upon the goods and services available to their citizens, rather than their gold reserves.[4] 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.

Examples

Example 1

Figure 1
Hours of work necessary to produce one unit
Country Cloth Wine
England 80 100
Portugal 120 90
Figure 2
Hours of work to commit after the specialization
Country Cloth Wine
England 80 + 100 0
Portugal 0 90 + 120

According to Figure 1, England commits 80 hours of labor to produce one unit of cloth, which is fewer than Portugal's hours of work necessary to produce one unit of cloth. England is able to produce one unit of cloth with fewer hours of labor, therefore England has an absolute advantage in the production of cloth. On the other hand, Portugal commits 90 hours to produce one unit of wine, which is fewer than England's hours of work necessary to produce one unit of wine. Therefore, Portugal has an absolute advantage in the production of wine.

If the two countries specialize in producing the good for which they have the absolute advantage, and if they exchange part of the good with each other, both of the two countries can end up with more of each good than they would have in the absence of trade.[5][6] In the absence of trade, each country produces one unit of cloth and one unit of wine, i.e. a combined total production of 2 units of cloth and 2 units of wine. Here, if England commits all of its labor (80+100) for the production of cloth for which England has the absolute advantage, England produces (80+100)÷80=2.25 units of cloth. On the other hand, if Portugal commits all of its labor (90+120) for the production of wine, Portugal produces (90+120)÷90=2.33... units of wine. The combined total production in this case is 2.25 units of cloth and 2.33 units of wine which is greater than the total production of each good had there been no specialization. Assuming free trade this will lead to cheaper prices for both goods for both countries.

Example 2

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

Further reading

See also

References

  1. 1 2 3 "ABSOLUTE AND COMPARATIVE ADVANTAGE" (PDF). INTERNATIONAL ENCYCLOPEDIA OF THE SOCIAL SCIENCES, 2ND EDITION. pp. 1–2. Retrieved 2009-05-04.
  2. ↑ "Absolute Advantage". Prentice Hall. 2004. Retrieved 2009-05-04.
  3. ↑ Marrewijk, Charles van (2007-01-18). "absolute advantage" (PDF). Department of Economics, Erasmus University Rotterdam:world economy. Princeton University Press. Retrieved 2009-05-03.
  4. ↑ Harrington, James W. "International Trade Theory". Geography 349 Absolute advantage. University of Washington. Retrieved 2009-05-04.
  5. ↑ Bruce Bueno de Mesquita (2013), Principles of International Politics, SAGE, pp. 329–330
  6. ↑ Teofilo C. Daquila (2005), The Economies of Southeast Asia: Indonesia, Malaysia, Philippines, Singapore, and Thailand, Nova Publishers, p. 124
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