What is Absolute Advantage?
Absolute advantage is the ability of an individual, company, region, or country to produce a greater quantity of a good or service with the same quantity of inputs per unit of time, or to produce the same quantity of a good or service per unit of time using a lesser quantity of inputs, than another entity that produces the same good or service. An entity with an absolute advantage can produce a product or service at a lower absolute cost per unit using a smaller number of inputs or a more efficient process than another entity producing the same good or service.
- Absolute advantage is when a producer can produce a good or service in greater quantity for the same cost, or the same quantity at lower cost, than other producers.
- Absolute advantage can be the basis for large gains from trade between producers of different goods with different absolute advantages.
- By specialization, division of labor, and trade, producers with different absolute advantages can always gain over producing in isolation.
- Absolute advantage is related to comparative advantage, which can open up even more widespread opportunities for the division of labor and gains from trade.
Basic Concept Of Absolute Advantage
Understanding Absolute Advantage
The concept of absolute advantage was developed by Adam Smith in his book Wealth of Nations to show how countries can gain from trade by specializing in producing and exporting the goods that they can produce more efficiently than other countries. Countries with an absolute advantage can decide to specialize in producing and selling a specific good or service and use the funds that good or service generates to purchase goods and services from other countries.
By Smith’s argument, specializing in the products that they each have an absolute advantage in and then trading products, can make all countries better off, as long as they each have at least one product for which they hold an absolute advantage over other nations.
General Example of Absolute Advantage
Consider the two hypothetical countries, Atlantica and Krasnovia, with equivalent populations and resource endowments, which each produce two products, Guns and Bacon. Each year Atlantica can produce either 12 Guns or 6 slabs of Bacon, while Krasnovia can produce either 6 Guns or 12 slabs of Bacon. Each country needs a minimum of 4 Guns and 4 slabs of Bacon to survive. In a state of autarky, producing solely on their own for their own needs, Atlantica can spend ⅓ of the year making Guns and ⅔ making Bacon for a total of 4 Guns and 4 slabs of Bacon. Krasnovia can spend ⅓ of the year making Bacon and ⅔ making Guns to produce the same, 4 Guns and 4 slabs of Bacon. This leaves each country at the brink of survival, with barely enough Guns and Bacon to go around. However, not that Atlantica has an absolute advantage in producing Guns, and Krasnovia has an absolute advantage in producing Bacon.
Absolute advantage also explains why it makes sense for individuals, businesses and countries to trade. Since each has advantages in producing certain goods and services, both entities can benefit from trade.
If each country were to specialize in their absolute advantage, Atlantica could make 12 Guns and no Bacon, while Krasnovia makes no Guns and 12 slabs of Bacon. By specializing, the two countries divide the tasks of their labor between them. If they then trade 6 Guns for 6 slabs of Bacon, each country would then have 6 of each. Both countries would now be better off than before, because each would have 6 Guns and 6 Bacon, as opposed to 4 of each good which they could produce on their own.
This mutual gain from trade forms the basis of Adam Smith’s argument that specialization, the division of labor, and subsequent trade leads to an overall increase of wealth from which all can benefit. This, Smith believed, was the root cause of the eponymous Wealth of Nations.
Absolute Advantage and Comparative Advantage
Absolute advantage can be contrasted to comparative advantage, which is when a producer has a lower opportunity cost to produce a good or service than another producer. Absolute advantage leads to unambiguous gains from specialization and trade only in cases where each producer has an absolute advantage in producing some good. If a producer lacks any absolute advantage then Adam Smith’s argument would not necessarily apply. However, the producer and its trading partners might still be able to realized gains from trade if they can specialize based on their respective comparative advantages instead.