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What Is Absolute Advantage?
Absolute advantage is the ability of one entity—whether that’s a single person, a company, or an entire nation party—to produce more of a particular commodity than its competitors can produce while using the same amount of resources.
In the aforementioned example of paper production, an international paper conglomerate is better equipped to process an entire grove of trees than an individual would be. The conglomerate’s presumed access to capital, equipment, employees, and transportation would dwarf those possessed by one individual person. Therefore the conglomerate enjoys an absolute advantage in the harvestation of that grove of trees. Simply stated, it can produce more paper than the individual can.
What Is the Origin of Absolute Advantage?
Absolute advantage theory traces back to the eighteenth century Scottish economist Adam Smith. In The Wealth of Nations (published in 1776), Smith argued for a capitalist symbiosis between nations. He observed that different countries had an absolute advantage in certain forms of industry, but that no nation had an absolute advantage in all industries. Therefore, Smith advocated international trade so that one country’s exports could be another country’s imports.
For instance, in Smith’s day, rum was a popular commodity in both Europe and the Americas. Rum is created from fermented sugar, and sugar grows best in warm climates. Thus the warm, tropical islands of the Caribbean—recently colonized by Europeans—had an absolute advantage in the production of sugar. But those islands did not house the machinery needed to efficiently ferment that sugar, bottle it, and ship it around the globe. European nations had such machinery and infrastructure, and thus they had an absolute advantage in the actual rum processing, once the raw materials were present.
Smith also proposed the concept of economies of scale. In essence this says that large-scale enterprises, which produce large quantities of certain goods, are able to produce their products at a much lower unit price than small-scale producers. To cite the paper example, it will cost the international conglomerate a lot less money to produce a sheet of paper than it would cost you as an individual working alone.
Absolute Advantage vs. Comparative Advantage: What’s the Difference?
Absolute advantage refers to the total amount of a product different entities are able to produce. The concept of comparative advantage is similar, but it also factors in efficiency. In the aforementioned paper example, not only is the international conglomerate able to produce more paper from a grove of trees than an individual could, but it can also do so at a lower opportunity cost—and its machinery would allow the work to be done in fewer hours.
Absolute and comparative advantage do not always run hand in hand. When comparing two countries, it is possible for one to have a greater absolute advantage in the production of goods while the other one has a greater comparative advantage. This is due to factors of production.
Consider the differences between the United States and Vietnam in the production of clothing.
- The United States has a larger workforce, a greater supply of cotton and other resources, and more comprehensive infrastructure than Vietnam. It is capable of producing a greater overall volume of clothing and thus has an absolute advantage in that market.
- But Vietnam, despite having fewer resources, actually has a comparative advantage over the United States in this market. This is due to its low-cost labor. Simply put, workers in Vietnam are paid less than their American counterparts, and factory real estate is also available at a lower cost.
- The U.S. gains from trade with Vietnam because Vietnam’s comparative advantage in the clothing industry makes prices desirable for American consumers. But American garment workers are hurt by trade with Vietnam because their jobs are lost to a region with a great comparative advantage.
- Vietnam gains from trade with the U.S. because of the quantity of clothing demanded by the American market outflanks what Vietnamese producers could sell domestically. Thus by exporting their goods, they propel their own economic growth. The disadvantage to Vietnam is that it becomes dependent on low wages. This implies that if another country emerges as a cheaper place to manufacture clothing, the industry may migrate to that new country.
The nature of international economics causes industries to gravitate toward regions with the lowest opportunity cost. When there is free trade among nations, companies know they stand to gain from producing their goods at the lowest possible cost and then shipping it to consumer markets. It would therefore follow that comparative advantage may be a more important factor in the production of goods than absolute advantage.
The theory of comparative advantage was introduced by economist David Ricardo in On the Principles of Political Economy and Taxation. It was published in 1817, forty-one years after Smith’s Wealth of Nations.
Learn more about economics and society with Nobel-prize winning economist Paul Krugman here.