Absolute vs. Comparative Advantage: An Overview
The division and specialization of production in the global economy is shaped by two key principles of capitalism: absolute advantage and comparative advantage. While absolute advantage indicates which nation is best at producing a given good, comparative advantage is an indication of which nation stands to lose the least by choosing to produce one good versus another.
- Absolute advantage is achieved when one producer is able to produce a competitive product using fewer resources, or the same resources in less time.
- Comparative advantage considers the opportunity cost when assessing the viability of a product, accounting for alternative products.
- Opportunity cost compares choosing one option over another, and how much the producer benefits or loses by doing so.
A nation or company is said to have an absolute advantage if it requires fewer resources—generally raw materials, manpower, or time—to produce a given item. For example, assume France and the United States both produce airplanes. In one month, France can produce 14 planes while the U.S can churn out 45 of comparable quality. This means it takes France 2.14 days to manufacture each plane versus the U.S. rate of 0.67 days.
In the above example, the U.S. has the absolute advantage because its ability to produce high-quality products at a quicker rate than its competition indicates a more efficient production model or more available and more talented labor.
While absolute advantage can be used to compare similar production, it does not take into account the opportunity cost of choosing one product over another, possibly more beneficial one.
Comparative advantage is all about reducing the opportunity cost of a given production strategy. The opportunity cost of producing a particular item is equal to the potential benefit that could have been gained by choosing an alternative. It is also what a business or country misses out on when choosing one option over another.
Assume that, utilizing the same amount of time and resources, China can produce either 30 computers or 45 cellphones. The opportunity cost of manufacturing one computer is 45/30, or 1.5 cellphones. Conversely, the opportunity cost of producing one cellphone is 30/45, or 0.67 of a computer.
Comparative advantage comes into play when neighboring Thailand decides it can also produce computers or cellphones, but not both. If Thailand's opportunity cost for producing cellphones is lower than 0.67 of a computer, then it has a comparative advantage for the production of cellphones. In this case, it is mutually beneficial for Thailand to produce phones and China to produce computers.
Even if China is more efficient at producing both items, giving it the absolute advantage, establishing specialized production and arranging an international trade agreement allows both countries to benefit.