Absolute Advantage
Absolute Advantage
The ability to produce the same quantity of a good or service using fewer resources per unit of time.
The theory of absolute advantage by Adam Smith indicates a country is more efficient in production if it uses fewer resources to produce a good.
- In other words, the country uses the same resources as another and yet, produces more goods.
Assume there are two countries, $A$ and $B$, who produce either only beef or only leather.
The table below shows how much each country produces per one worker in one day if the worker produced either only beef or only leather.
- Therefore if a worker in country A produces 8 kilos of beef then they produce 0 metres of leather
- Or they do 2 meters of leather so 0 kilos of beef.
| Country | Kilos of beef | Metres of leather |
|---|---|---|
| A | 8 | 2 |
| B | 5 | 4 |
Country $A$ has an absolute advantage in producing beef because with the same number of resources (one worker), it produces more beef.
However, country $B$ has an absolute advantage in producing leather because with the same number of resources, it produces more leather.
The example above showcases the scenario where reciprocal absolute advantage exists.
- However, this is not always the case as sometimes, a country could have absolute advantage in producing all the goods.
We can use the information in the example above to construct the PPCs of each country.
- For simplicity, we use a straight-line PPC implying constant opportunity costs.
The figure above shows the PPCs for each country which we can construct by noticing the quantity produced per worker (assuming there is only one worker in each country).
- Hence for country $A$, if it producers 8 units of beef then it produces 0 units of leather showcasing its intercept on the vertical axis at $(0,8)$
- If it produces 2 units of leather, then it producers 0 units of beef indicating its intercept on the horizontal axis at $(2,0)$
- By drawing a straight line across the two points, we create the PPC for country $A$ assuming constant opportunity costs.
We can repeat the process to get the PPC of country $B$.
As observed in the diagram:
- The PPC of country $A$ extends (intercepts) further up the vertical axis than the PPC of country $B$ indicating the absolute advantage of $A$ in beef production.
- Similarly, the PPC of country $B$ extends (intercepts) further right the horizontal axis than the PPC of country $A$ indicating the absolute advantage of $B$ in leather production.
There can be cases where a countries PPC sits entirely above on both axis indicating absolute advantage in both goods.
Hence, if a country specialises in the good they have absolute advantage in, then:
- Country $A$ can produce only beef while country $B$ produces only leather.
- Therefore, country $A$ can export its beef to country $B$ which exports its leather to country $A$.
Hence absolute advantage encourages production of goods to those who are more efficient, which leads to more production for the same resources worldwide (efficient production throughout the world).
Further:
- Even though countries produce within their PPC, due to the trade caused by absolute advantage, it is possible to consume outside of the PPC.
- This is because by importing goods from a more efficient country, you can consume more than you could have alone (seen in the figure).
This is the reallocation of resources such that production takes place in countries with lower costs.
Comparative Advantage
Comparative Advantage
A country having lower opportunity costs in the production of a good compared to another country.
The concept of absolute advantage only explains a small section of gains from trade and specialising in production.
Economist David Ricardo with his theory of comparative advantage showed that countries can benefit from trade even if one has absolute advantage in all goods as long as they have different opportunity costs.
ExampleAssume again there are two countries, $A$ and $B$, who produce either only beef or only leather.
The table below shows how much each country produces per one worker in one day if the worker produced either only beef or only leather.
- Therefore if a worker in country A produces 20 kilos of beef then they produce 0 metres of leather
- Or they do 10 meters of leather and so 0 kilos of beef.
| Country | Kilos of beef | Metres of leather |
|---|---|---|
| A | 20 | 10 |
| B | 10 | 2 |
Hence, it can be seen country $A$ has an absolute advantage in both goods since it can produce more beef and more leather using the same resources in the same time.
Using the example above, we can draw the PPCs for country $A$ and $B$.
This time, country $A$ has absolute advantage in both goods because its PPC lies entirely above country $B$.
NoteIntersection on the graph indicates absolute advantage to each country, but no intersection implies one country has absolute advantage in both.
Hence, it is important to determine if there is a comparative advantage by comparing opportunity costs, to understand which good each country should specialise in.
Opportunity cost
The value of the next best option that must be forgone or sacrificed in order to acquire something else.
