Absolute Advantage: Definition, Benefits, and Example
Understanding Absolute Advantage
An individual, business, area, or nation has an absolute advantage if it can create more goods or services per unit of time using the same inputs as its rivals or create the same amount of goods or services per unit of time using fewer inputs.
Absolute advantage can be attained by utilizing fewer inputs or a more effective method to produce the item or service at a lower absolute cost per unit.
Adam Smith, an economist from the 18th century, introduced the idea of absolute advantage in his book The Wealth of Nationsto explain how countries might profit from trade by specializing in manufacturing and exporting the things they can manufacture more successfully than other countries. Absolute winners may concentrate on producing and marketing a certain thing or service and then utilize the proceeds to purchase goods and services from other countries.
Smith argued that if each nation specialized in the commodities in which it had a distinct competitive advantage over other nations, then selling the goods may be advantageous to all nations as long as each nation had at least one such good.
The rationale for why it is advantageous for people, companies, and nations to trade with one another is based on absolute advantage. Each has a distinct edge in manufacturing certain items and services; therefore, the exchange will be advantageous to both parties.
Smith's claim that specialization, the division of labour, and subsequent commerce result in an overall increase in wealth from which all can profit is based on this idea of mutual gain through trade. According to Smith, this served as the foundation for the so-called "Wealth of Nations" book.
Comparative Advantage vs Absolute Advantage
Comparative advantage, which occurs when one producer has a lower opportunity cost to supply an item or service than another producer, can be compared with absolute advantage. The potential gains that a person, investor, or company forgoes by selecting one choice over another are known as opportunity costs.
Time specialization and commerce yield clear advantages only when one producer has an absolute advantage over others in producing a certain good. If all producers had absolute advantages, then Adam Smith's claim would not necessarily be valid.
However, if the producer and its trading partners can instead specialize based on their comparative advantages, they may still be able to profit from the trade. Despite having an absolute advantage in trading a range of items, David Ricardo argued in his book "On the Principles of Political Economy and Taxation" that trade with other nations may still be advantageous if they have different comparative advantages.
Presumptions between Theories
To explain the advantages of commerce, Smith's theory of absolute advantage and Ricardo's theory of comparative advantage both rely on certain presumptions and simplifications. They are:
Obstacles to Trade
Both theories assume that there are no trade restrictions. They don't consider any shipping expenses or additional duties that a nation could impose on products imported from another. However, in the real world, transportation costs have an influence on how likely importers and exporters are to conduct business. Tariffs can also be used by nations to give themselves an edge over rivals or to disadvantage them.
Various Production Factors
Additionally, both models presuppose that the production's inputs are often stationary. These models forbid enterprises and employees from moving in quest of better possibilities. In the 1700s, this presumption was valid, but not anymore.
Globalization has recently made it simple for businesses to relocate their manufacturing abroad in modern trade. Additionally, it has boosted the pace of immigration, which affects a nation's labour force. Some corporations may collaborate with governments to establish immigration chances. This can be beneficial for employees who are crucial to the firms.
Continuity and Size
More importantly, both models assume that the absolute advantage of a nation is constant and scales similarly. In other words, it simply implies that manufacturing fewer items has a similar per-unit cost to creating more of them and that nations are unable to alter their inherent advantages.
In truth, nations frequently undertake strategic investments to gain an edge in particular industries. In addition to investment-related factors, absolute advantage can also fluctuate based on various aspects. Farmland, industries, and other production elements, for instance, can be destroyed by natural catastrophes.
Benefits of the theory of Absolute Advantage
The notion of absolute advantage has the benefit of being straightforward. The idea offers a sophisticated justification for the advantages of trade, demonstrating how nations may profit by concentrating on their own assets.
However, the idea of comparative advantage falls short of properly illuminating how trade benefits different countries. This reasoning would support Ricardo's comparative advantage theory: even if one nation has a definite edge in all categories of commodities, the trade will still benefit that nation. In other words, even if one nation can create all items at a lower cost than its trade partners, it will still profit from doing business abroad.
As previously mentioned, the theory also holds that absolute advantages are static, meaning that they cannot be altered and do not improve with size. However, this is incorrect, as evidenced by the fact that many nations have invested in critical industries to gain a decisive competitive edge.
Throughout reality, in the postcolonial age, the argument has been employed to defend oppressive economic practices. Major institutions like the World Bank and IMF have frequently pushed developing nations to prioritize agricultural exports rather than industrialization because all nations should concentrate on their advantages. As a result, many of these nations continue to experience slow economic growth.
Absolute Advantage: Pros and Cons
How does Absolute Advantage help a country?
Adam Smith introduced the idea of Absolute Advantage in "The Wealth of Nations" to demonstrate how nations might profit by specializing in manufacturing and exporting the things they produce more effectively than other nations, as well as by purchasing the goods that other nations create more efficiently. As long as each nation has at least one product with a clear competitive edge over the other, both nations can gain from specializing in and trading those goods accordingly. It is illustrated in a better way in the next section of this article with an example.
An Illustration of Absolute Advantage
Let's compare the demographics and resource endowments of two hypothetical countries, Atlantica and Pacifica, that produce two goods-guns and bacon-and have similar almost populations. Atlantica can only make six slabs of bacon or twelve butter tubs each year, compared to Pacifica's six tubs of butter or twelve bacon slabs.
Each nation requires a minimum of four bacon slabs and four butter tubs to survive. In an autocratic society, Atlantica might generate four tubs of butter and four slabs of bacon by creating butter for one-third of the year and bacon for the other two-thirds. This will fulfil the needs at an exact rate.
To make the same amount of bacon and butter, four tubs of butter and four slabs of bacon, Pacifica may spend one-third of the year making bacon and two-thirds of the year making butter. Each nation is now on the verge of extinction, with limited butter and bacon for everyone. However, Pacifica has a clear edge in generating bacon, whereas Atlantica has a clear advantage in making butter.
Atlantica could produce 12 tubs of butter and no bacon in a year if a nation is specialized to the furthest extent possible. In contrast, Pacifica could produce 12 slabs of bacon and no butter. The two nations may then split the labour-intensive duties between them by specializing.
As a result, each nation would have six of each if they exchanged six tubs of butter for six slabs of bacon. Since each nation now has six tubs of butter and six slabs of bacon instead of the four of each item they might manufacture alone, they are better off than before.
The Bottom Line
Adam Smith's concept of absolute advantage illustrates how trade helps countries by allowing them to export goods where they have a clear advantage. Although the idea offered a beautiful and straightforward depiction of the advantages of trade, it only partially explained the concept. Later, David Ricardo's theory of comparative advantage added more, making it a fully proven concept.