What Is Absolute Advantage?

The ability to produce more of a good or service with the same amount of inputs per unit of time, or to produce the same amount of a good or service per unit of time using fewer inputs than competitors, is known as absolute advantage.

Producing the item at a lower absolute cost per unit via fewer inputs or a more efficient method might give a company an absolute cost advantage.

Understanding Absolute Advantage

Adam Smith, a prominent economist of the 18th century, created the notion of absolute advantage in his book The Wealth of Nations to demonstrate how nations benefit from trade by focusing on the production and export of those items for which they have a comparative advantage. Countries with a significant advantage in one area may focus on that area’s production and exports to create export revenues.

Smith contended that, so long as each country has at least one commodity for which it has an absolute advantage over other countries, specialization in those items and subsequent trade may make all countries better off.

The concept of absolute advantage may explain reasons for trade between people, companies, and nations. Because of their respective strengths, both parties stand to gain from the transaction.

Smith argues that specialization, the division of labor, and subsequent commerce lead to a rise in affluence from which everyone may profit, and this mutual gain from trade is the foundation for this argument. Smith thought this was the fundamental cause of the phenomenon he called the “Wealth of Nations.”

Absolute Advantage vs. Comparative Advantage

In contrast to having a lower opportunity cost to provide an item or service than a rival manufacturer, who has an absolute advantage. A person, investor, or company’s “opportunity cost” is the value of the rewards they forego because they choose one option over another.

Only when each producer has an absolute advantage in providing some product can specialization and trade lead to clear benefits. Adam Smith’s reasoning may not hold water if a manufacturer has no absolute advantage in the market.

However, if the producer and its trading partners can specialize according to their comparative advantages, they may still benefit from trade.
In his book On the Principles of Political Economy and Taxation, David Ricardo stated that a nation might gain by trading with other countries even if it had an absolute advantage over trading numerous products.

Assumptions of the Theory of Absolute Advantage

The assumptions and simplifications used by Smith’s theory of absolute advantage and Ricardo’s theory of comparative advantage to explain the advantages of trade are similar.

Barriers to Trade

Both models presuppose that there are no constraints on commercial activity. Shipping expenses and any extra duties one nation may impose on imports from another are not included.

An Enquiry into the Nature and Causes of the Wealth of Nations, by Adam Smith, in Electronic Text Format, Published by Project Gutenberg.

But in the actual world, transportation costs affect the likelihood of commerce for both the importer and the exporter. Tariffs are another tool countries may use to gain an edge or disadvantage rivals.

Factors of Production

Both models similarly presume that production factors are fixed in place. In these scenarios, neither employees nor companies leave for better prospects elsewhere. In the 1700s, this was a reasonable assumption.

However, globalization has made it simpler than ever for businesses to set up shop in other countries. The availability of workers in a nation has been affected by the rise in immigration. In some sectors, employers will collaborate with governments to facilitate immigration for people crucial to the sector’s success.

Consistency and Scale

What’s more essential is that the premise shared by these theories is that a country’s absolute advantage is fixed and linear. This theory holds that nations cannot alter their absolute advantages and that the cost of producing a few commodities is the same as producing a large quantity.

The truth is that nations often make calculated investments to gain a competitive edge in certain markets. Absolute advantage may shift for causes outside of capital expenditures. To provide just one example, natural catastrophes may wipe out agriculture, industry, and other sources of economic output.

Pros and Cons of Absolute Advantage

The absolute advantage hypothesis is advantageous due to its ease of use: In a very elegant way, the theory explains why trade is beneficial and how individual nations may reap the most benefits by emphasizing their comparative advantages.

The notion of comparative advantage helps, but it doesn’t tell us all we need to know about how and why trading helps countries. Ricardo’s idea of comparative advantage would eventually account for this phenomenon. One country’s overwhelming superiority in both sorts of commodities does not negate the fact that it may benefit from trade. Therefore, even if a country can manufacture all items at a lower cost than its trading partners, it will still gain by engaging in international trade.

As previously said, the theory implies that absolute advantages are fixed, meaning that a nation cannot alter its advantages and that its efficiency does not increase with size. As history has demonstrated, however, this is not the case: By putting money into key businesses, several nations have established unrivaled monopolies on the market.

The argument has been utilized to defend exploitative economic practices adopted in the postcolonial period. The World Bank and the International Monetary Fund (IMF) have argued that all nations should play to their strengths. Therefore they have often pushed developing nations to prioritize agricultural exports above industrialization. Many of these nations’ economies, as a consequence, have not advanced much.

Example of Absolute Advantage

Take the fictional nations of Atlantica and Pacifica, both of which produce the staples of Western diets: butter and bacon. Twelve butter tubs or six bacon slabs may be produced annually in Atlantica. In contrast, twelve tubs of butter or twelve slabs of bacon can be produced annually in Pacifica.

Four tubs of butter and four rashers of bacon are essential for every nation’s survival. Atlantica may spend one-third of the year creating butter and two-thirds manufacturing bacon, yielding four tubs of butter and four slabs of bacon in a state of autarky, producing only for their own needs.

The same amount of bacon and butter (four tubs of butter and four slabs of bacon) may be made if Pacifica spends one-third of the year creating bacon and the other two-thirds producing butter. There will be barely enough butter and bacon to go around, putting each nation on the verge of collapse. While Atlantica and Pacifica are equally adept at turning out delicious bacon and butter, the former region has the upper hand.

If both countries focused only on what they did best, Atlantica would produce 12 tubs of butter and zero slabs of bacon yearly, whereas Pacifica would do the opposite. The two nations split the work between them by focusing on their strengths.

Each nation would have six of one item after the trade: six butter tubs for six slabs of bacon. With six tubs of butter and six slabs of bacon between them, rather than the four of each that any country could produce on its own, the economies of both nations would improve.

How Can Absolute Advantage Benefit a Nation?